RBI Wary Of Market Call For More Liquidity Amid Muted Demand From Banks

Money market participants, led by banks, have been pushing the Reserve Bank of India to provide more liquidity in recent meetings, but the central bank is keen to provide liquidity via a 14-day variable rate repo only once there is a clear sign that the system is in deficit, according to two banking industry professionals with knowledge of the matter.

In every meeting, there is a demand for more liquidity from banks, but when the RBI offers a 14-day VRR or five-day VRR, there is a lack of demand, said one of the persons quoted above on condition of anonymity. This is making the RBI unsure of whether banks want the liquidity or just want the comfort that the RBI will provide liquidity, regardless of the prevailing situation, the person said.

BQ Prime had exclusively reported on Feb. 7 that the RBI was keen to move back to the 14-day variable rate repo as its main policy signalling tool as the overall market conditions returned to pre-pandemic levels.

The RBI announced a 14-day VRR for a sum of Rs 500 billion on Feb. 10 and received bids worth Rs 1.33 lakh crores.

However, when the RBI conducted a 14-day VRR for Rs 1 lakh crore on March 10, it received bids for a lower amount of Rs 826.50 billion.

Subsequently, in a financial-year-end measure, the RBI offered a five-day VRR worth Rs 75,000 crore on March 24, but received bids for just Rs 55,885 crore.

Separately, there is also scrutiny of how much liquidity is being availed under the standing liquidity facility that has been offered to standalone primary dealers, the second person quoted above said.

According to market estimates, the current excess liquidity in the system is around Rs 1 lakh crore, which is also reflecting a recent pick-up in government spending.

However, the markets argue that this amount of liquidity surplus can get quickly used up with the system moving to neutral or deficit if there are major outflows such as goods and services, advance tax payments, currency market outflows, or foreign portfolio outflows.

The RBI, on the other hand, has pointed out that even as credit demand remains strong, banks have additional statutory liquidity ratio holdings of around 4–6%  and should draw down on those for credit redeployment to productive sectors.

The RBI is also critical of banks that continue to deploy excess liquidity in the Standing Deposit Facility while seeking fresh liquidity windows from the central bank, the second person quoted above said. 

In this scenario, the RBI is attempting to ensure the market has adequate liquidity without there being too much money sloshing around, which will have a cascading impact on its other objectives such as policy transmission and containing inflation, the first person quoted above said.

The 14-day VRR is the tool for transmitting policy cues as per the liquidity framework, and it will be used as and when the RBI believes the system is genuinely in deficit. Over time, the intent will be that as liquidity tightens in the system, the 14-day VRR will return to a regular schedule, the second person quoted above said.