Liquidity absorption toolkit comes to fore as RBI stresses on 'withdrawal'

The Reserve Bank of India's latest actions suggest it may lean toward absorbing surplus liquidity from banks, revisiting some tools if necessary to ensure excess funds in the system do not run counter to its aim of withdrawing accommodation.

While the RBI has preferred Variable Rate Reverse Repo (VRRR) auctions to mop up excess liquidity, its toolkit includes options such as sales of government bonds, an increase in the Cash Reserve Ratio (CRR), the use of the Market Stabilisation Scheme (MSS) and foreign exchange swaps.

Excess liquidity with banks is currently just above ₹2 lakh crore. Deposits of ₹2,000 notes and a higher-than-budgeted surplus transfer from the RBI to the government have improved liquidity conditions.

"During the Lehman situation, we had the MSS. That kind of an option is still open," said Bank of Baroda chief economist Madan Sabnavis.

"Anything to do with an OMO (open market operation) is a permanent infusion or withdrawal," he said. "OMO sale of securities is something which looks possible. One month back we were all talking in terms of RBI coming in with OMOs to provide liquidity, now we need to absorb liquidity."

The RBI's assessment of how resilient the economy is will determine how it acts, analysts said.

"I think most of the liquidity management is going to be done keeping in mind that it should not have a negative effect on growth," said Rahul Bajoria, managing director, Barclays. "If the assessment of growth improves, then maybe some more direct measures to withdraw liquidity might come back on the table."

WHAT CAN RBI DO?
Judging by the alacrity with which the RBI has conducted VRRR auctions over the last week, it's clear that the central bank aims to prevent the swollen liquidity surplus from undoing the transmission of the rate hikes it carried out from May to February. Surplus liquidity typically brings down short-term interest rates.