The Reserve Bank of India said it will resume normal liquidity management operations as the economy and financial market conditions stabilise. It’s early steps that will help target the price of liquidity by pushing up short-term rates even as the banking system remains flush with funds.
“On a review of evolving liquidity and financial conditions, it has been decided to restore normal liquidity management operations in a phased manner,” the central bank said in a release on Friday.
Alongside, it announced the resumption of variable rate reverse repo auctions. The first such auction will be held for a maximum amount of Rs 2 lakh crore on Jan. 15, 2021.
The auction will permit banks to park surplus funds with the RBI while earning near the reverse repo rate of 3.35%. The actual rate gets determined using the auction. However, since a larger amount of funds will get parked at close to 3.35%, the incentive to lend at lower rates reduces. As such, very low short-term rates on treasury bills and commercial paper may move up marginally. To be sure, mutual funds and insurance companies, that do not have access to the reverse repo window, may continue to park surplus liquidity at rates below the reverse repo rate.
In a note in December, Kaushik Das, chief India economist at Deutsche Bank, had said “there is scope for the RBI to announce some measures to rectify the price of liquidity before the February 2021 monetary policy meeting.” The next steps could be aimed at the extent of surplus liquidity. While India’s Monetary Policy Committee will likely maintain an accommodative stance at its February policy, it “may provide some signal regarding the need for right-sizing the quantum of excess liquidity and aligning short-term interest rates to the reverse repo rate of 3.35%, if the divergence continues until then”, Das had said in a Jan 5. note.