While the borrowing amount started to increase on 22nd July, the squeeze was really felt on 25th July when the amount borrowed under MSF exceeded the amount parked under SDF. In the absence of meaningful spending coming through, the banking overnight liquidity slipped into a deficit, forcing banks to borrow money from the RBI at the MSF rate.
RBI’s efforts to stem the volatility in the FX markets also consumed part of the surpluses. A build-up in GOI’s cash balances due to GST collections, direct tax collections ahead of the filing deadline and scheduled auctions reduced liquidity surpluses with banks. The second half of July has been particularly challenging from a liquidity standpoint. Note that RBI does not lend funds at the Repo rate (currently 4.90%) every day. Thus, overnight rates can swing between 4.65%, when overnight liquidity is abundant, and 5.15%, when overnight liquidity is tight. This implies that on any day, the overnight rate would gravitate towards either side depending on whether banks have excess or deficit liquidity on that day. However, lately there has been some break in this trend.īefore we proceed further, it is pertinent to understand that RBI ‘lends’ overnight liquidity to the banking system at the Marginal Standing Facility ( MSF) rate (currently 5.15%) and ‘accepts’ excess overnight liquidity from the banking system at the Standing Deposit Facility rate (currently, 4.65%). The arrangement worked well, with banks gradually calibrating their deployment under the tool after accounting for expected permanent reduction in liquidity (increase in CIC, FX interventions by RBI, increase in CRR) and temporary reduction in liquidity (increase in government cash balances with RBI through tax payments and scheduled auctions). Impact on the yield curve was more measured as the VRRR increased the overall cost of liquidity gradually. The interest burden was borne by the RBI, and the use of the instrument by banks was discretionary. The rate for this was close to the repo rate against lower levels of reverse repo rate - where the bulk of parking was done. With this tool, banks had flexibility to park their excess liquidity for an amount they were comfortable with, for a short tenor (up to 28 days, but mostly for 14 days). Thus, RBI used an unconventional tool – variable rate reverse repos (VRRRs).
This may not be desirable as the economy is still recovering from the pandemic. Using the same instrument this time would have meant a significant amount of MSS issuance, leading to an increased interest burden on the government (since MSS coupon liability is part of the GoI budget), and a higher yield curve. This overhang was even higher than post-demonetisation levels in 2016.Īt that time, RBI resorted to issuing T-Bills under Market Stabilisation Scheme (MSS) to absorb the excess liquidity. Since RBI expressed its intent in 2021 to roll back its emergency liquidity, it has contended with one significant issue the extent of liquidity overhang was just too high.