RBI may open SDF window to address liquidity issues

The Monetary Policy Committee (MPC) meeting is scheduled for the first week of April. As MPC has already shifted to a neutral stance from accommodative in February policy meeting, no action on the policy rate (repo rate is at 6.25%) is expected. However, market would keenly watch out for actions /announcements on the interbank-liquidity management.

The MPC has reiterated over the last two meetings to bring back interbank liquidity to neutral. However, liquidity surplus continues to remain in excess of Rs 4 lakh crore. Even if we assume that surplus liquidity might normalise over next 12 months, it still leaves the policymakers to deal with the problem of plenty and its implications over the next few quarters. Excess liquidity has pushed the overnight rate and other money market rates below the repo rate which is not congruent with the MPC's neutral monetary policy stance. Also, existing liquidity has probably restrained Reserve Bank of India (RBI's) intervention in the FX market leading to sharp appreciation of the rupee in the recent past. Foreign portfolio inflows have picked up sharply, with combined net inflows in local debt and equities at c.USD 6.8 billion (Rs 45,000 crore) year to date. Sterilisation of these inflows could have further exacerbated the domestic liquidity surplus.

So what tools can be deployed to manage the existing excess liquidity? Since the beginning of 2017 the RBI has switched its reliance from market stabilisation schemes (MSS) to reverse repo auctions to manage liquidity. As the current episode of liquidity mismatch seems to be more durable, there is a need for increased deployment of permanent tools like cash reserve ratio (CRR) changes, open market operations (purchase / sale of bonds) or market stabilisation schemes.

However, these permanent tools have their own sets of limitations- (i) there is a cap of Rs 1 lakh crore on MSS issuances in FY18 (ii) CRR is perceived as a blunt tool with additional cost implications for banks as it is unremunerative (iii) policymakers have to bear a cost for liquidity management with implications for government's fiscal deficit -in fact similar cost is also incurred on reverse repo auctions.

Thus, it's possible that authorities are considering creating a new facility called standing deposit facility (SDF). Newswires have been reporting this over the last week. SDF would absorb the surplus interbank liquidity at a rate lower than the repo rate (currently 6.25%) and thus, reduce the cost of liquidity management and without the need for collateral (repo/ reverse window requires collaterals). However, if SDF was introduced at a rate lower than repo rate, it would lower short-end money market rates and can raise credibility issues around the MPC's current neutral stance on rates.

Thus, while the market will keenly watch out the combination of tools which RBI could deploy to manage liquidity over next few months, measures to ensure credibility of monetary policy stance will be equally important.

The writer is head, South Asia Economic Research (India), Standard Chartered Bank, India