The current liquidity conditions, which require the RBI to infuse and suck out liquidity in the banking system at times, are being driven by exogenous factors, which are likely to correct in the foreseeable future, aided by the central bank’s market operations, according to Governor Shaktikanta Das.

Das emphasised that the Reserve Bank remains nimble and flexible in its liquidity management through two-way main and fine-tuning operations, in both repo (infusing liquidity) and reverse repo (sucking out liquidity).

“We will deploy an appropriate mix of instruments to modulate both frictional and durable liquidity, so as to ensure that money market interest rates evolve in an orderly manner and financial stability is maintained,” he said.

money market

The reduction in liquidity deficit in the last few days has led to overnight money market rates to move towards the Standing Deposit Facility (SDF) rate of 6.25 per cent.

When the monetary policy stance is “withdrawal of accommodation”, the overnight money market rates should hover between the repo rate (6.50 per cent) and the marginal standing facility (MSF) rate (6.75 per cent).

So, the RBI has conducted six variable rate reverse repo (VRRR) auctions during February 2-7 to suck out liquidity and push up the overnight rates towards the repo rate (6.50 per cent), in keeping with the policy stance.

At times when the liquidity deficit widens, the RBI conducts variable rate repo (VRR) auctions to provide liquidity. With banks’ credit growth exceeding deposit growth, they need liquidity support from RBI.

The Governor observed that financial market segments have adjusted to the evolving liquidity conditions in varying degrees.

“While the short-term rates have fluctuated, long term rates have remained relatively stable, reflecting better anchoring of inflation expectations as indicated in the softening of term spread in the G-sec market. In the credit market, monetary transmission remains incomplete,” he said.

Das reiterated that RBI’s policy stance is in terms of interest rate, which is the principal tool of monetary policy in the current framework.

“Our stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation ruling above the target of 4 per cent and our efforts to bring it back to the target on a durable basis,” he said.

Suyash Choudhary, Head- Fixed Income, Bandhan Mutual Fund, noted that RBI’s liquidity approach has evolved since late last year.

“Thus while the entire rate hike cycle was conducted in an environment of abundantly surplus liquidity, since late last year the central bank had started to worry about the quantum of excess system liquidity as well. This was presumably to facilitate greater transmission from banks,” he said.

In the most recent period, however, the RBI has become more responsive to anchoring overnight rate towards repo.

“While the Governor has noted that core liquidity remains positive, this is expected to progressively deteriorate into the financial year end predominantly on account of seasonal rise in currency in circulation.

“This, alongside ongoing large fluctuations in government cash balance, may require continued active intervention to anchor overnight rates.” said Choudhary.

In all likelihood, overnight rates will range between repo and MSF over the next month and a half; with zero tolerance from the RBI for it falling below repo rate, he added.