RBI's liquidity test may set future course
The Reserve Bank of India is currently grappling with a notable liquidity dilemma due to a surge in FCNR(B) scheme inflows. To navigate this, a pivotal variable rate reverse repo auction is set to influence the liquidity management strategy. The central bank may also utilize measures such as dollar swaps and bond sales.
Mumbai witnessed the Reserve Bank of India (RBI) conducting a variable rate reverse repo (VRRR) auction on Monday to absorb ₹7 lakh crore of liquidity generated by the FCNR(B) scheme. The success of the outcome of this 30-day auction will determine how the central bank manages this record liquidity, according to market participants. They believe additional tools such as dollar swaps and bond sales through open market operations (OMOs) may be necessary to sterilise the large liquidity injection.
A high participation rate in the VRRR auction would imply that the RBI's endeavour to maintain neutral liquidity has been partially successful. Emkay Global economist Madhavi Arora stated that extinguishing $36 billion of forward dollar positions within a year would also help absorb the rupee liquidity from the FCNR scheme. She anticipated the RBI to employ a mix of tools, including bond sales through OMOs and sell-buy dollar swaps, to draw rupees from the banking system.
The RBI's liquidity management has been crucial due to the total FCNR inflows of $136 billion significantly exceeding the initial forecasts of $80-90 billion. This implies that around $50 billion (approximately ₹5 lakh crore) of excess liquidity has been generated. OMOs of bonds might not be an ideal option, as additional bond supply could lead to higher yields and make government borrowing more expensive.
The central bank might opt to sell bonds with three to five-year maturities, aligning the tenure with the liquidity generated by the FCNR scheme.
Bankers anticipate more VRRR auctions to ensure effective medium-term liquidity management, depending on the outcomes of the first auction. CSB Bank's head treasury, Alok Singh, mentioned that the RBI has previously conducted a 90-day VRRR auction, which remains a possibility. The RBI granted participants the option for premature withdrawal of lent amounts, as liquidity could tighten due to advance tax outflows on September 15.
Although global liquidity is abundant, its uneven distribution among banks hinders efficient deployment, as short-term rates have dropped significantly while longer-term rates remain relatively stable.
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.
