RBI modifies tight stance on liquidity

In the wake of the “extreme” stress on liquidity last Friday, the Reserve Bank of India (RBI) today said it would ensure the fund flow was adequate, while not diluting monetary policy transmission.

Even though a liquidity deficit was consistent with an anti-inflation stance, excessive deficiency could be disruptive for both financial markets and credit growth, RBI said in its second quarter review of monetary policy in 2010-11.

There are legitimate concerns that the deficit, seen from the huge borrowing at the liquidity adjustment facility (LAF) window, was significantly in excess of the comfort zone of one per cent (plus\minus) of net demand and time liabilities (NDTL) of banks, RBI said.

Last Friday, call rates touched a two-year high of 12 per cent, as liquidity was scarce due to huge demand from mutual funds to meet redemption obligations. The fund flow for Coal India Ltd’s public offer also put stress on the system. RBI opened a special liquidity window till November 4. It allowed banks to borrow up to one per cent of liabilities at LAF. It relaxed the 25 per cent statutory liquidity ratio norm and waived the fine for maintaining less than the ratio.

It will also buy back some government bonds on November 4 to infuse liquidity. It had conducted a similar activity in the third week of October. To ensure economic activity was not disrupted by liquidity constraints, the liquidity deficit needed to be contained within a reasonable limit, it added.

RBI has been keeping an eye on liquidity to strengthen the transmission from policy rates to commercial lending rates at a time of inflationary expectations. Liquidity conditions, which remained tight between end-May and July due to huge outflow from the system, eased in August. After alternating between surplus and deficit for a brief period, the LAF window has remained in the injection mode since September 9. The average daily net injection in September was around Rs 24,000 crore. It was Rs 61,700 crore in October. A peak injection of Rs 1, 28,685 crore took place on October 30.

While this has been consistent with the stated policy stance, the sharp changes have largely been due to significant increases in government cash balances, which stood at Rs 77,736 crore as on October 30.

To alleviate frictional liquidity pressure, RBI on October 29 decided to conduct a second LAF and allowed scheduled commercial banks to avail of additional support under LAF to up to one per cent of their NDTL as on October 8.

The high level of government balances indicates the tight liquidity is likely to ease to some extent, as the government draws these down in the coming weeks. On the basis of the large telecom spectrum auction realisations, buoyant tax revenues and anticipation of significant inflows from disinvestment during the year, the government announced it would pare its market borrowing by Rs 10,000 crore in the second half of the financial year.