RBI: Keeping liquidity in deficit mode is needed, but not easy

The Reserve Bank of India (RBI) on Friday said a challenge for effective transmission of monetary policy was to keep systemic liquidity in a deficit.

"Our empirical evidence suggests that the transmission of policy signals to the operating target and other short-term market interest rates is most effective under deficit liquidity conditions," said Deepak Mohanty, executive director of RBI, in a speech at the Indian Institute of Management, Lucknow, on Friday.

Since May, the central bank has moved toward having a single policy rate. Mohanty said the past three months' experience suggested the overnight interest rate was more stable, following implementation of the new procedure.

"The strength of transmission through the interest rate channel depends on several factors, particularly on liquidity conditions. Recent experience suggests that as long as systemic liquidity was in surplus, the transmission of policy signal was weak. But once systemic liquidity turned into deficit, the response of the overnight call rate to policy rate was stronger," he said.