More changes in the RBI Liquidity Management Framework are likely after the daily dynamic VRR (variable rate repo) has been taken as the first step to manage liquidity in the banking system, according to an SBI research report.
“Such changes and frontloading next round of moves are smart and pragmatic by the RBI…A delicate mix of temporary and permanent liquidity injection and withdrawal remains a work in progress,” the report states.
As a corollary to intervention in the forex markets juxtaposed with volatile movements in government cash balances, liquidity has been shrinking in the banking system and alarmingly blowing past the comfort zone
This persistent liquidity conundrum, along with the anticipation of a rally in DXY has prompted the regulator to revert to daily dynamic VRR to effectively manage the liquidity along the revised LMF (Liquidity Management Framework) in place from February 2020.
Given that such daily VRR transactions are akin to transient liquidity injections, repo transactions should ideally compensate for changes in government cash balances, but this is somehow also substituting for permanent durable liquidity shortfall arising out of currency leakage and liquidity impact of RBI forex intervention, the report observes.
“To negate this, in a smart move RBI has started to sell in Spot and NDF forwards and then doing short-term buy-sell swaps to replace the maturing forward sale position and also to counter the durable liquidity drain from spot intervention. We also think RBI may announce longer term (2-3 years) buy sell swaps to shore up reserves and release liquidity,” according to the SBI report.
In principle, liquidity management still has some operational challenges like improving the market microstructure, a proper indicator of liquidity tightness in the system and most importantly maintaining a delicate balance between an effective mix of durable and transient liquidity injection or withdrawal, the report points out.
According to the report, the system liquidity situation remained tight and turned to injection mode since 16 December 2024, due to many reasons like tax outflows, GST payment, forex market intervention and volatility in capital flows. Further with the implementation of Just in Time (JIT), the system liquidity has been impacted through movements in government cash balances
System liquidity moved from a surplus of Rs 1.35 lakh crore in November to a deficit of Rs 0.65 lakh crore in December, further to Rs 1.58 lakh crore deficit in January (till January 16). If we look at the injection-absorption ratio, which has increased to about 4 X, indicating persistent borrowings from the LAF window, the report added.
(IANS)
