Within six months of the return to the Reserve Bank of India’s (RBI’s) revised liquidity management framework, the overnight standing deposit facility (SDF) has replaced the reverse repo window as banks’ preferred route for parking surplus cash.
As successive waves of the Covid-19 pandemic receded and economic conditions showed signs of normalising, the RBI in its February policy announced its decision to restore the revised liquidity management framework. The transition began with the move to the 14-day variable rate reverse repo (VRRR) auction as the main operation from the fixed rate reverse repo.
Since the move to normal liquidity operations, the daily average liquidity surplus has steadily shrunk from Rs 8.5 trillion at its peak. The surplus stood at Rs 1.7 trillion, as of July 19, according to a note from Bank of Baroda.
“The system liquidity surplus (adjusted for CRR build up) came marginally lower than our expectations led by slower pace of government spending and likely RBI forex sales to cap pace of rupee depreciation,” said Kotak Mahindra Bank in a note on Tuesday. On a week-on-week basis, the average liquidity surplus last week decreased toRs 2.3 trillion fromRs 2.78 trillion surplus in the previous week, the note said.
Currency in circulation (CIC) has risen toRs 30.79 trillion as of July 1, 2022, fromRs 28.81 trillion as of December 31, 2021. The RBI’s fight against rupee depreciation has cost it part of its foreign currency assets, which are down to $518 billion as on July 8 from $569 billion as on January 7. The dollar sales have played a role in sucking rupee liquidity, as has the cash reserve ratio (CRR) hike of 50 basis points (bps) to 4.5%.
Ashutosh Khajuria, executive director & CFO, Federal Bank, said system liquidity has fallen with a rise in currency in circulation and spending of reserves by the RBI. “Over the last few months, the SDF has become the preferred route to park excess liquidity as banks can do so at their discretion. There are fewer VRRR (variable rate reverse repo) auctions now,” he said. A pickup in credit demand also means the overnight SDF window works better for banks than locking up funds under the 14-day VRRR.
Other market participants believe that even as the RBI stays the course on liquidity normalisation, it will be careful not to hurt growth. Ajay Manglunia, managing director and head of debt capital markets at JM Financial, said apart from the other measures, the RBI has also sold a small quantum of G-Secs in the open market.
“From here on, the RBI would like to keep sufficient liquidity rather than excess, and they will try to prevent a situation where the market is liquidity-starved. There is still some scope to withdraw liquidity and so these measures will continue. By end-September, the surplus may be at Rs 1-1.5 trillion,” Manglunia said.
There is an expectation of liquidity tightness emerging as the festive season rolls in. Soumyajit Niyogi, director, core analytical group, India Ratings and Research, said a chunk of the liquidity withdrawal has happened due to equity market outflows and a widening in the current account deficit.
“The CIC has risen by aroundRs 10 trillion from pre-Covid levels. By September-end, the surplus liquidity should be aroundRs 2 trillion. But in October, with the beginning of the festive season, CIC could rise further accompanied by a drop in liquidity to below 1% of NDTL. That could be cause for worry,” Niyogi said.