With government borrowings likely to increase in the current fiscal, there is a need to increase the demand for bonds and conduct reverse repo as well as term reverse repo operations without placing any collateral with the Reserve Bank of India, says a report.
For conducting such reverse repo operations, the Reserve Bank of India Act needs to be amended, the research report by State Bank of India (SBI) - Ecowrap noted.
"Given that 2020 is going to be an exceptional year with government borrowings set to jump, we believe the time has now come for increasing the demand for bonds by having the necessary amendment in the RBI Act used effectively so that conduct of reverse repo and term reverse repo operations are completely non-collateralized," it said.
Reverse repo is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent. Under reverse repo operations, banks deposit excess funds with the Reserve Bank of India (RBI) and earn interest on it.
As lending to the central bank has no credit risk, there is no need to provide government securities as collateral when a market participant places its funds with the RBI, the report said.
"Additionally, since securities obtained under reverse repo are eligible for statutory liquidity ratio (SLR), it will thus ensure an overall increase in the demand for bonds," the report said.
With the continuous liquidity support by RBI, the system surplus liquidity position has increased significantly and banks have parked an average of Rs 6 lakh crore in May, compared to Rs 4.8 lakh crore in April and Rs 2.9 lakh crore in March under the reverse repo window of RBI.
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The report said in order to absorb surplus liquidity from the system without the need for providing collateral in exchange, RBI has been planning to introduce a (low) remunerated standing deposit facility (SDF).
The Urjit Patel Monetary Policy Committee had recommended this instrument and indicated that this would be done with the discretion to set the interest rate without reference to the policy target rate.
The committee recommended that the introduction of the standing deposit facility will require amendment to the RBI Act and may replace reverse repo in the long-run.
"We believe that such uncollateralised absorption of liquidity by the central bank will pave the way for the government to suck out additional liquidity at lower cost through SDF," the report said.
The report also recommended that there should not be any cap on the amount of funds placed at the RBI window for reverse repo, rather it should be abandoned and SDF should be introduced.
"Capping the quantum of funds in reverse repo as was done in 2007 creates significant market distortions in the onshore rate pricing metric as well as the knock on impact on the FX pricing metric," it said.