Liquidity management: Weighted average call rate to continue as target rate, says RBI panel

By: |
Published: September 27, 2019 12:50:57 AM

The group observed that the current liquidity management framework should largely continue in its present form — a corridor system with the call money rate as the target rate.

The central bank should also have the freedom with respect to the instruments to be used as well as the tenor of operationThe central bank should also have the freedom with respect to the instruments to be used as well as the tenor of operation

The Reserve Bank of India (RBI) on Thursday released the much-awaited report of the internal working group to review the liquidity management framework.

The group observed that the current liquidity management framework should largely continue in its present form — a corridor system with the call money rate as the target rate.

“The framework should enable the central bank to be equipped with the required tools to inject and absorb liquidity at either fixed or variable rates, on an overnight basis as well as for longer tenors. The central bank should also have the freedom with respect to the instruments to be used as well as the tenor of operation,” it said.

The report stated that the design of the corridor system, with repo rate as the policy rate, would generally require the system liquidity to be in a small deficit of about 0.25%-0.5% of the net demand and time liablities (NDTL) of the banking system. Market experts point out that this is a sign that the central bank may not be comfortable with higher system deficits.

“However, if financial conditions warrant a situation of liquidity surplus, the framework could be used flexibly, with variable rate operations to ensure that the call money rate remains close to the policy repo rate. Thus, liquidity operations should take into consideration the prevailing conditions, based on which the required tools will be used to achieve the objectives of liquidity management framework,” the report said.

The working group also stated that it is important that the liquidity management framework does not undermine the price discovery process in the inter-bank money market. “Particularly, the framework should incentivise banks to trade among themselves rather than with the central bank because the transmission process crucially depends on market forces working efficiently,” the report pointed out.

The group also stated that build-up of a large deficit or surplus, if expected to persist, should be offset through appropriate durable liquidity operations. In addition to open market operations (OMOs) and forex swaps, the group recommended longer term repo operations at market related rates.

“The fact that the group has explicitly stated about the potential use of appropriate tools for managing liquidity, provides a sort of assurance that short term money market rates will not go haywire,” said a bond market expert.

Do you know What is Cash Reserve Ratio (CRR), Finance Bill, Fiscal Policy in India, Expenditure Budget, Customs Duty? FE Knowledge Desk explains each of these and more in detail at Financial Express Explained. Also get Live BSE/NSE Stock Prices, latest NAV of Mutual Funds, Best equity funds, Top Gainers, Top Losers on Financial Express. Don’t forget to try our free Income Tax Calculator tool.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Atmanirbhar Bharat not about import substitution; here’s what the Modi’s self-reliant India means
2Ordinances on inter-state farm trade, contract farming out of judicial process
3Overcoming clearance delays: Embedded approvals for mineral blocks