RBI panel suggests longer-term repo operations to manage liquidity

An RBI internal working group has suggested introduction of longer-term repo operations at market-related rates of up to one-year tenor as an alternative to open market operations conducted by the central government to manage liquidity in the banking system.

The RBI had set up the internal working group to review the current liquidity management framework with a view to simplify it and suggest measures to clearly communicate the objectives and the toolkit for liquidity management.

According to the group's report put up on the RBI's website on Thursday, the panel has recommended that the current liquidity management framework should largely continue in its present form -- a corridor system with the call money rate as the target rate. Comments have been invited from stakeholder till October 31.

The framework should be flexible. While the corridor system would normally require the system liquidity to be in a small deficit, if financial conditions warrant a situation of liquidity surplus, the framework should be adaptable, it said.

On managing durable liquidity, the panel has recommended that, as an alternative to OMO purchases, "longer-term variable rate repos, of more than 14 days and up to one-year tenor, be considered as a new tool for injection if system liquidity is in a large deficit".

Similarly, longer-term variable-rate reverse-repos could be used to absorb excess liquidity. As these are possible substitutes for OMOs, these instruments should be operated at market determined rates.

The RBI resorts to OMOs to manage liquidity by selling or purchasing government securities.

Further, the group has suggested that the current difference of 25 basis points between the repo rate and the reverse-repo rate, as well as between the repo rate and the marginal standing facility (MSF) rate, be retained.

Also, the standing liquidity facilities -- fixed rate reverse repo and MSF -- may continue at present.

It also acknowledged that the present minimum requirement of maintaining 90 per cent of the prescribed cash reserve ratio (CRR) on a daily basis has helped avoid bunching of reserve requirements of individual banks.

Hence, the group recommends that this minimum requirement be retained at the current level, said the report.

It also noted that surplus liquidity in a normal situation may have adverse implications for the economy in the form of excessive credit growth, misallocation of liquidity, and creation of asset price bubbles.

Liquidity operations of the Reserve Bank of India are essentially operations to equilibrate reserve holdings of banks.

Liquidity management, which is the operating procedure of monetary policy, seeks to ensure adequate liquidity in the system so that sufficient credit is provided to all productive sectors in the economy.

The current liquidity framework operates as a corridor system with the repo rate as the policy rate.

Under the present framework, banks have access to fixed rate repo up to 0.25 per cent of their all deposits and up to 0.75 per cent of the banking system deposits through four 14-day variable rate term repo auctions.