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Informist, Tuesday, Mar. 25, 2025

 

By Siddharth Upasani

 

NEW DELHI - The Reserve Bank of India has had three liquidity management frameworks over the last decade or so. And if the last three months are anything to go by, the central bank has probably started moving towards a fourth.

 

Starting December, banking system liquidity has gone from surplus to a massive deficit, thanks to a variety of factors: scheduled tax outflows, currency leakages due to festival-related spending by households, and the RBI's foreign exchange interventions. And it is now moving towards surplus again due to rapid action from the RBI, so much so that analysts are of the opinion that Mint Street's thinking has changed.

 

"...the RBI has been forthcoming in announcing measures, which to us suggests the RBI could want the system to move into a surplus rather than remaining in deficit," Nomura rates strategist Nathan Sribalasundaram said in a note earlier this month. "This raises the question of whether the MIBOR/WACR (weighted average call rate) can sustain below the repo rate. We believe we are moving in this direction."

 

But while it is well-nigh impossible to have a liquidity framework for all seasons, a central bank cannot ordinarily operate as the RBI has in recent months for the current system is severely lacking. Take, for instance, the weighted average call rate--the operating target of liquidity management--which is bordering on the obsolete.

 

WACR TO SORR

Over the years, the role of the call market has diminished so much so that its share in total money market volumes fell to 2.3% in 2023-24 (Apr-Mar) from 21.5% in FY12. This isn't just a case of other segments such as market and triparty repo growing faster; the volume in call was down 31% in FY24 compared to 12 years ago. Consequently, the call rate doesn't represent the marginal cost of funds for banks.

 

It is no surprise then that the committee on the MIBOR benchmark recommended last year the creation of the Secured Overnight Rupee Rate, or SORR, based on secured money market rates as it would better represent market funding rates. In December, the RBI accepted the creation of SORR as a benchmark.

 

What the aforementioned committee stopped short of saying--likely because it fell out of its remit--was that the RBI must target the SORR, noting that "...the Committee also recognised that a benchmark based on the call money rates which is the operating target for monetary policy is likely to be the preferred benchmark for derivatives used to take a view on monetary policy actions". Clearly, without the RBI moving to SORR from the weighted average call rate, the new benchmark may not amount to much. According to Soumya Kanti Ghosh, State Bank of India's group chief economic adviser, "there is an urgent need to revisit the existing liquidity management framework by RBI by replacing the WACR as a policy rate as it does not serve the intended purpose."

 

FRAMEWORK REVISION

A move to SORR as the operating target of monetary policy will require a complete re-look of the liquidity management framework of the RBI. And it would not be a surprise if the RBI has already begun an internal review of the framework.

 

The increase in intensity with which the RBI has acted has coincided with Sanjay Malhotra taking over as governor and Deputy Governor T. Rabi Sankar being given temporary charge of Financial Markets Operations Department in mid-January. At the same time, the central bank has seemingly become more receptive to suggestions from the market. But not all suggestions, such as bringing back the daily fixed rate repo window, may be received with an open mind.

 

It was back in 2013 that the RBI, under D. Subbarao, capped banks' recourse to the daily fixed rate repo window to 1% of net demand and time liabilities on the now-infamous night of Jul. 15. Over the years, it was progressively reduced to just 0.25?fore being withdrawn completely in February 2020. As such, it would be a massive shock if the RBI brought back the said window as it would allow market players to essentially outsource their liquidity management to the RBI; the central bank is the lender of last resort, not first.

 

The RBI needs do more than just move to the SORR from the weighted average call rate and put to bed calls for the revival of the fixed rate repo window; it must also do better than using frequent variable rate repo operations--which are to tide over temporary liquidity problems--as a substitute for durable liquidity deficits.

 

The path ahead of the RBI is fairly clear: it must target the benchmark that paints a correct picture of funding conditions. This can be done either by moving to the SORR once it is developed or somehow increasing volumes in the call market. The former is seemingly the route it is on and will require revisiting the liquidity framework.  End

 

Edited by Vandana Hingorani

 

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