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Published on 12/06/2019 9:36:18 AM | Source: HT Media

RBI`s liquidity framework needs to make money available at right time

Posted in Economy News| #RBI #Economy #Banking Sector #Expert Views

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To plot the tension in the relationship between the Reserve Bank of India (RBI) and the markets, all one needs to do is follow the ebb and flow of liquidity.

Over the past two years, the anger towards the central bank has increased and has pushed it to take a relook at the way it approaches liquidity. In short, an overhaul of the liquidity framework was demanded.

The result is that an internal group made of RBI staff will come up with a new framework by mid-July. The task is to simplify liquidity management by spelling out the why, how and what of liquidity.

When the central bank’s staff begins to hammer out a new framework, they should keep in mind that more communication is good communication.

The main demand of markets is that RBI spell out a liquidity stance along with its monetary policy stance. A contrasting stance on policy and liquidity has muddled the message of the central bank to the markets, and the economy has paid the price for it in the past.

What RBI needs is to spell out its intentions with liquidity, and target not just the price of money but the quantum as well. It would also not hurt to expand the toolkit to include high-quality corporate bonds as collateral for repo operations.

“To start with, they should target quantum of liquidity, and not just the price measure which is the weighted average call rate. RBI should spell out a strategy through a liquidity stance as the situation demands," said Ananth Narayan G., associate professor of finance at SP Jain Institute of Management and Research in Mumbai.

R. Sivakumar, head (fixed income) at Axis Mutual fund, agrees. “The big problem is that currently RBI deals with liquidity mainly from the interbank perspective and targets only the overnight rates. But repo rate gets irrelevant in transactions between banks and customers," he said.

Transmission has been a struggle for RBI and it acknowledged that full transmission of past policy rate cuts is still to be done. As the adjoining chart shows, liquidity is in a surplus mode now, following the central bank’s forex swaps and massive bond purchases.

That said, the journey to surplus has been long and painful.

Indranil Sengupta, chief economist at Bank of America Merrill Lynch, believes the central bank should infuse liquidity at the beginning of the fiscal year. “One rupee provided by RBI takes six months to morph into one rupee of credit and hence, it makes sense to provide that rupee right at the beginning," he said.

To please the markets, the central bank’s staff need to demonstrate they are putting in place a method to provide required liquidity at the right time.