RBI braces to tackle gush of liquidity from securities glut, inflation risk

The Reserve Bank of India (RBI) is gearing up to manage an anticipated surge in liquidity in the banking system over the short term.

Liquidity in the banking system is soon expected to skyrocket as ₹1.4 trillion in government securities come due this month, along with the inflow of month-end salaries.

To begin with, RBI is expected to sell government securities via open market operations (OMO) in a bid to mop up a significant portion of the gush of liquidity, analysts said.

“RBI may look to conduct OMO sales next month. Government securities worth ₹1.4 trillion maturing in November, along with the month-end inflow of salaries, may push systemic liquidity into surplus,” Sarbartho Mukherjee, a senior economist at CareEdge, said.

In September, the banking regulator gradually stopped using a special policy called the incremental cash reserve ratio (ICRR), which was introduced a month earlier to drain excess liquidity from the banking system.

To be sure, RBI primarily rolled out ICRR to absorb the surplus liquidity that was being generated by the return of the ₹2,000 currency notes into the banking system. While rolling out the policy measure, the regulator had said that ICRR was a temporary step.

“With the discontinuation of ICRR, the deficit in systemic liquidity has reduced significantly. The overall deficit in systemic liquidity is now marginally negative compared to a deficit of ₹1.6 trillion a month ago,” CareEdge’s Mukherjee said.

Meanwhile, a $5-billion foreign exchange swap is set to mature this week, with analysts expecting the banking regulator to roll it over in its bid to contain liquidity with the aim of keeping inflation in check rather than shoring up its forex reserves.

A forex swap is an agreement to exchange currencies now and reverse the trade later, aimed at controlling liquidity and inflation.

The maturity of the central bank dollar/rupee swap transaction has sparked concerns over the availability of dollars in the system, foreign exchange traders said, adding that RBI may roll over the maturity deadline to avoid the possibility of a dollar shortage.

RBI had sold $5 billion to banks on 28 April last year under the dollar/rupee swap transaction, with the clause of buying them back at maturity, which falls on 23 October, Monday.

The Economic Times reported last week that RBI may extend the maturity deadline as the central bank is concerned about inflationary risks due to excess liquidity with banks in the festival season.

During festive periods, increased consumer spending drives up demand for currency, which effectively soaks up liquidity in the system. The RBI selling dollars and buying up rupees, if it chooses to go ahead with the forex swap, also absorbs some of the rupee liquidity in the market.

“A rise in currency demand in the festive season, along with RBI’s forex intervention to stem volatility in exchange rate, can counteract any increase in rupee liquidity,” Mukherjee said.

Meanwhile, large banks were taking steps to ensure that they do not face a dollar crunch and were raising dollars by conducting USD/INR buy/sell swaps to receive dollars on the spot rate, CNBC TV-18 reported.

Earlier this month, RBI governor Shaktikanta Das had asked banks with surplus funds to explore the interbank call market option rather than parking their money in the standing deposit facility (SDF).

The interbank call market is a platform where banks lend to and borrow from each other on a short-term basis, while SDF allows banks to deposit excess funds with RBI at a fixed interest rate.