RBI Liquidity measures

In my two earlier posts, I had commented on the interest rate decision and on the RBI Monetary Policy Report. In this post, I want to comment on the liquidity enhancement measures that the central bank had taken.

To understand the liquidity-enhancement measures that the RBI took, read this excellent comment by Tamal Bandyopadhyay. My friend R. Jagannathan (‘Jaggi’) cheekily called it QE1. It is true that when the central bank announces its intention to bring down the liquidity deficit from 1% of Net Demand and Time Liabilities (NDTL) to a neutral level, it would mean asset purchase from commercial banks in return for cash. That is QE, technically.

[Note, however, that the central bank cannot bring this deficit down in a short time frame. That would mean too much of liquidity in the short run. Tamal notes that it might take as much as two years. Also, note that the aim is to bring the average liquidity deficit to zero. Not necessarily every day. The system could be in deficit on some days. In that sense, the Repo Rate will be operative.

Only when the system is never in a liquidity shortage, will the Repo rate cease to be the reference rate for cost of funds for the banks. It would become the Reverse Repo rate. There won’t be any interest rate corridor. Only one rate would matter. If the system is so adequately flooded with liquidity, effectively it means that the central bank has cut interest rates very aggressively. But, we are a long way off from that.

In another aside, since eliminating the liquidity deficit to zero might take two years, Tamal makes a very thoughtful point that, in effect, RBI has promised easy monetary policy for two years!]

But, it is not quite so. In that sense, all central banks engage in asset purchase and sale when they engage in Open Market Operations (OMO). They are always buying assets from and selling assets to commercial banks. That is done to steer the overnight borrowing rate closer to the policy rate. It is not done in lieu of interest rate policy.

What distinguishes QE from normal OMO is its duration (for how long?) and quantum (how much of asset buying is involved?). I would add that QE is distinct from normal OMO in the sense that it is used when conventional monetary policy tool – the interest rate – is no longer usable. That is, rates are at 0.0%. Of course, these days, central banks are going negative! So, the question is whether they should be doing QE at all, if they can go negative on rates.

Well, for effect, the central bank can offer funds to banks at negative rates (paying banks to borrow!)  and buying assets to influence interest rates at all maturities and at all risk profiles! Whether it has any effect on the real economy or not is a different matter, altogether. RBI does not believe it has. Read the comment it had on western monetary policies in the box in the closing pages of its monetary policy report:

Although the overall objective has been to raise economic growth and counter deflationary conditions by deterring saving, and encouraging borrowing and risk taking, scepticism has developed about the efficacy of the policy in achieving anything beyond inflating asset prices and depreciating currencies competitively.

RBI is dead right.



4 thoughts on “RBI Liquidity measures

  1. Sir,

    In one comment RBI Gov said it may take 1 year time to move into liquidity neutral zone from deficit in the press conference immediately after the monetary policy announcement where he responded to question – how long it will RBI to move into liquidity neutral position. (https://www.youtube.com/watch?v=1aYlYCk3SFo&feature=youtu.be comment during 9 minute onwards)

    However, in the conference call later in afternoon with economists and researchers, Mr Rajiv Radhakrishnan of SBI MF asked the RBI that – What is time frame RBI anticipates to bring the liquidity deficit to neutral with given current estimates of reserve money growth with the changes in liquidity management?

    Summarizing the answer by Dr Rajan – “well it depends how much you consider is the liquidity deficit. To get a sense what we are talking about, if the real money growth is broadly consistent with the needs of economy most estimates on how much the RBI’s asset side of balance sheet needs to grow would be 15 – 20K Cr’s a month. So, If you take that, as we would infuse in general through forex purchases as well as purchases of domestic bonds and say add to that 10K Cr a month we tried to create liquidity deficit. Depending on how much you think liquidity deficit in system is, you get a sense how long it will take. Not giving forecast how long it will take.
    If the deficit is 1% of NDTL which would be roughly 80,000 Cr then it will take us 8 months to cover”

    you cane listen to audio of the conference here https://rbidocs.rbi.org.in/rdocs/content/Mp3/RBI032016040518609050416.mp3 and to listen the above conversation, plz play from 3 minute onward)

    Now, one wonders how much time it will take to erase the deficit, there is no explicit commitment to keep liquidity in surplus. Can we term this as QE?


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