How RBI could tackle a liquidity deluge triggered by dollar deposits
The RBI’s special dollar deposit scheme attracted a massive $127.23 billion, pushing India’s banking system liquidity surplus to a record ₹9.70 trillion. The central bank may deploy longer-term VRRR auctions, FX swaps, a market stabilisation scheme, CRR hikes or open-market bond sales to absorb excess liquidity and prevent inflationary pressures from building.
The Reserve Bank of India (RBI) received an unprecedented $127.23 billion in dollar deposits through its special scheme, causing the liquidity surplus in India's banking system to soar to a record high of 9.70 trillion rupees ($102.70 billion). This surplus has traders and central bank officials debating how to absorb the excess funds, as allowing it to accumulate could fuel inflation.
Traditionally, the RBI handles excess liquidity through overnight to seven-day variable rate reverse repo (VRRR) auctions, which lock up liquidity for a few days. However, the RBI could also consider conducting longer-term VRRRs, giving banks the option to reverse the position early. This approach was successful during the beginning of the year, potentially providing a mutually beneficial solution for all parties involved.
Another option is employing shorter tenor dollar-rupee sell-buy swaps, where the RBI sells dollars or takes delivery of a portion of its forward positions, thereby draining rupee liquidity. Estimates suggest that the central bank might be comfortable taking delivery of around $32 billion from its forward book, which is set to mature in a year.
The RBI and the government could also reintroduce the market stabilisation scheme, last employed in 2017 after high-value currency notes were withdrawn, leading to a spike in liquidity in the banking system. Under this scheme, the government sells shorter-tenor Treasury bills, which could soak up surplus liquidity for up to a year. However, the government often avoids this tool due to the interest payments it entails.
The cash reserve ratio, the proportion of deposits that banks must hold as reserves, is another standard tool the RBI uses to manage liquidity. Currently set at 3%, the central bank might temporarily increase the CRR requirement, particularly for the discounted window deposits. A 50 basis point hike in CRR could extract around 1.4 trillion rupees, while a 100 bps increase could potentially remove 2.8 trillion rupees from the system.
Lastly, the RBI can sell government bonds to investors to withdraw liquidity, although this move would also push up bond yields. The RBI's estimated holdings suggest that such sales are likely to focus on the three-year to 10-year segment.
Written by urgent.news from The Economic Times - Economy's reporting — not their text. Machine-written — may contain errors; check the original before relying on it.
