RBI's $ buys see liquidity at a high

Banks were awash with liquidity as outflows on account of government bond auctions paled in comparison to the rupees injected into the system as a result of dollar purchases by the Reserve Bank of India (RBI) over the last few days, to prevent the Indian currency from appreciating.

The overnight rates continued at last week's range of below 1 per cent.

The extent of liquidity in the banking system can be gauged from the bids received by the RBI at its reverse repo auctions.

Bids for a total of Rs 1,10,000 crore were received, more than double the amount of bids received most of last week. The rupee today closed lower at Rs 40.71 to the dollar, against Rs 40.66 yesterday, depreciating from last week's nine-year high of Rs 40.28.

Reverse repo is the rate at which banks lend short-term money to the central bank against government securities.

Dealers said the RBI appears content with negligible overnight rates, rather than having to face an unbridled appreciation of the rupee.

They added that banks are facing a dilemma in investing surplus funds as the RBI has capped fund absorption through its reverse repo window at just Rs 3,000 crore a day.

Most banks did not have to borrow from the market because they had already set aside additional funds to maintain the cash reserve ratio (CRR), the amount of cash the government requires banks to deposit with the central bank, in the previous weeks, anticipating liquidity shortage.

Consequently, the call rate "" the interest one bank charges another while lending surplus funds "" closed today at 0.50 per cent. Being overnight borrowing, banks can neither use these funds for lending purposes nor invest in long-term instruments like bonds.

As a result, several of them are rushing to invest in liquid mutual fund schemes. Banks that have in-house mutual funds are facing the additional problem of managing excess funds on behalf of their mutual funds and furnishing additional CRR with the RBI.

While fears of another CRR hike loom over market participants, the liquidity seems to be triggering a small rally in government securities.

The RBI auctioned dated security "" 6.65 per cent 2010 "" for Rs 6,000 crore and 91-day and 364 day t-bills for Rs 5,000 crore this week under the market stabilisation scheme.

It also sold two government securities as part of government borrowing programme for Rs 9,000 crore on Tuesday.