Liquidity to be more in deficit: Subbarao

The Reserve Bank of India (RBI) expected systemic liquidity to be more in deficit than in surplus, RBI Governor D Subbarao said today. He was explaining the reason for RBI’s decision to narrow the corridor of repo and reverse repo rates in its quarterly monetary policy review yesterday.

“We expect systemic liquidity will be more in the deficit mode than in the surplus mode going forward,’’ Subbarao said in a teleconference with analysts and researchers. “There could be a marginal surplus.”

RBI yesterday raised the repo rate by 25 basis points, for the fourth time this year. It also raised the reverse repo rate by a higher-than-expected 50 basis points, thereby narrowing the so-called LAF (liquidity adjustment facility) corridor to 125 basis points from 150 basis points.

Since the end of May, banks have been net borrowers from the central bank under the two LAF auctions daily. Payment of advance income tax by companies and withdrawal of funds by telecom companies for payment of fees for spectrum licences reduced the liquidity in the banking system. Bankers expects liquidity to improve as the government begins spending. A statement by the central bank governor has changed that outlook. 

“There could be possibility of the rate oscillating in the upper band and the lower band of the LAF corridor,’’ Subbarao said.

“That could cause uncertainty and instability in the markets. The narrowing of the corridor was an outcome of that intention to reduce uncertainty.’’

The narrowing of the corridor would also help in better monetary transmission, he said. Among the reasons for the monetary transmission not being that effective included the benchmark prime lending rate system being opaque, surplus funds in the system, and subdued demand for loans in the system resulting in surplus liquidity, the governor explained. 

The notable thing about the narrowing of the corridor was an effort towards better monetary transmission, Subbarao said.