Amitava Sardar
The Liquidity Adjustment Facility (LAF) scheme – the principal arm of RBI’s monetary policy, had been introduced way back in April 1999. Since then, though the fundamental building blocks constituting the corridor with Repo Rate as the policy rate, Marginal Standing Facility (MSF) as the ceiling rate and Reverse Repo Rate as the floor rate have remained the same, the sheer variety of instruments and the rationalisations that have been brought to bear for managing systemic liquidity reflect RBI’s commitment to innovate and make best use of the circumstances. Yet at the same time, of late RBI appears to have been much more charitable in its operations which are at variance with the way its policy making body i.e., the Monetary Policy Committee (MPC) at least publicly professes. This also suits a Government that has been struggling to rein in its fiscal deficit.
First, under the current persistent surplus situation (except the turmoil caused recently by COVID-19), the variable rate reverse repo operations of different maturities have become the principal instrument for withdrawing liquidity. The pertinent issue here is whether their pricing is detrimental to the functioning of the inter-bank market.
It is worrisome that RBI has been drawing out huge liquidity virtually at the fixed overnight Repo Rate irrespective of the tenor of the variable rate reverse repo operations from the year 2014-15 since when detailed data are available. During 2019-20, the spread between the fixed rate overnight Repo and the cut-off rates of the variable rate overnight (as well as longer term) Reverse Repo stood at, on average, just 1 basis point. Reverse repos of 14-day, 42-day or 63-day were all being accepted at a uniform cut-off rate of 5.14 per cent relative to the overnight Policy Repo Rate of 5.15 per cent! Hence, there is neither any variability in rates nor any relationship with the term of these reverse repo operations.
On the liquidity injection side also, similar disregard has been noticed from the second half of 2016-17 in respect of 14-day variable rate repo auctions. Further, it is even more glaring that the LTROs (Long Term Repo Operations) of as long as 365 days and 1095 days conducted in February and March 2020 had the uniform cut-off rate of 5.15 per cent. In view of COVID-19, effective March 27, 2020, RBI has provided targeted long term repos of Rs. 1,00,000 crore for up to three years at a floating rate linked to the policy Repo Rate. Accordingly, repos of 1092-/1093-/1095-days have been done at the current repo rate of 4.4 per cent since March 27, 2020.
In this regard, it is instructive to revisit the operations of the MSS (Market Stabilization Scheme). Securities issued under MSS were generally part of the regular auctions of 91-day, 182-day and 364-day Treasury Bills. From 2007, those were also issued as dated securities. As a result, pricing of those securities reflected the full force of market dynamics at the time of auctions and cut-off rates moved at times well beyond the Policy Repo Rate.
In other words, RBI has been injecting and withdrawing liquidity almost at the same Policy Repo Rate irrespective of their maturity and kept the yield curve virtually flat for more than five years. This virtually amounts to yield curve control (YCC) as being practised by Bank of Japan from September 2016 and now Reserve Bank of Australia from March 2020. This has also given rise to a situation whereby RBI could be perceived as too obliging in the recent period. This practice combined with other measures as announced on March 27, 2020, April 17, 2020 and thereafter could, however, be justified in view of the extra-ordinary situation in the midst of COVID-19.
In fact, reflecting on RBI’s extra-ordinary accommodative stance, Jahangir Aziz in his article in Economic Times on February 20, 2020 apprehended whether under the new monetary policy framework, “MPC decides the overnight rate and the RBI the rest of the yield curve”! More recently, Dr. Urjit Patel, ex-Governor, RBI, in his article in Indian Express on April 28, 2020 raised even more fundamental issues on how of late monetary measures are being taken by RBI without any reference to the MPC.
Second, though the weighted average call money rate has been continuing as the operating target of the monetary policy, market dynamics has changed remarkably during the last two decades in that the share of the call money market in the aggregate overnight money market segment has dwindled from 31 per cent in 2006-07 to a mere 7 per cent in 2019-20. This market is also not deep enough as non-bank participants e.g., mutual funds, insurance companies, corporates etc., are ineligible to participate in it. As opposed to this, Tri-party Repo/CBLO (Collateralized Borrowing and Lending Obligation) being the most transparent and the deepest, has become the largest segment; its share went up progressively from 46 per cent to 69 per cent over this period. Under this circumstance, it is felt that the time has come to replace the weighted average call money rate with the general collateral overnight repo rate as the operating target of monetary policy. Among the major central banks, the Bank of Canada, the Bank of Mexico and the Bank of Brazil treat the general collateral overnight repo rate as the operating target of monetary policy. Simultaneously, RBI should revisit the restrictions placed on both banks and non-banks in the call money market in view of the stricter prudential restrictions now in place to make this market more broad based and deep.
Third, CRR (Cash Reserve Ratio) was at 4 per cent since February 9, 2013 until March 28, 2020 since when it has been reduced to 3.0 per cent for one year up to March 26, 2021. Further, CRR maintained on average basis over a fortnight had the daily requirement of a minimum of 90 per cent of the prescribed CRR that had been continuing since April 16, 2016. The Internal Working Group of RBI on Liquidity Management Framework (September 2019) justified continuation of this prescription as it “has helped avoid bunching of reserve requirements by individual banks”. This daily minimum, however, stands reduced to 80 per cent effective March 28, 2020 for a period up to June 26, 2020.
Now, leaving aside this one-time three-month dispensation, could we really call it an “averaging” system when the headroom available with banks is so little? Further, with a better liquidity forecasting mechanism in place combined with discretionary term repo and reverse repo instruments under LAF at its disposal, why should RBI be apprehensive of “bunching of reserve requirements by individual banks”?
In fact, RBI should analyse the behaviour of daily cash balances of banks with it under both surplus and deficit situations and then find out whether reserve requirements continue to remain binding on banks. If found binding, the requirement of a daily minimum of 90 per cent is clearly unfair to banks. In that event, RBI should also consider paying interest on such balances. On the contrary, if CRR is found not binding on banks, it would mean that settlement balances required to take care of banks’ own payment transactions are higher than the cash balances mandated under CRR. In that situation, it would be easier for RBI to reduce CRR even further, but the daily minimum must be escalated to 100 per cent. Further, an organic link should necessarily be established between its LAF and the intra-day liquidity (IDL) mechanism as available to participants under the real-time gross settlement (RTGS) system.
Amitava Sardar retired as Adviser from Reserve Bank of India. Views are personal.
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