Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Economy

RBI Mopping Up Excess Liquidity by Selling Govt Bonds

RBI’s selling bonds, and selling them big time. With India moving to what seems to be a liquidity glut in the banking system, with the RBI now having to lend out lesser and lesser every day:

image

The net injection is the sum of

  • Repo amounts (banks borrow overnight or for a short term)
  • minus Reverse repo amounts (banks park money with RBI for short term)
  • plus any overnight borrowings from the Marginal Standing Facility (excess borrowing).

We saw a brief up move because of the September 15 tax filing (when people pay taxes, the money goes into the government account into RBI and thus out of circulation, and thus banks borrow from the RBI)

RBI Now Selling Bonds to Reduce Liquidity

This net injection, however is temporary liquidity since banks only borrow or lend for a short term. If they are moving to net park money in the RBI, they have too much money available. One way to remove that from the system is for the RBI to sell bonds. (It could sell dollars too but at this time, selling dollars would be disastrous as the rupee nears Rs. 62 to the dollar)

Look at OMO bond sales in the market in FY 2014-15:

image

We have already see 125 bn (Rs. 12,500 cr.) being sold this year (there are nearly no purchases), where RBI has sold directly to the market.

Now the RBI also intends to cut liquidity even more:

Both these measures will reduce liquidity – cash will move from banks to the RBI in exchange for bonds. The former (the OMO sale) is permanent liquidity as the money doesn’t have to be returned The latter is temporary.

Is there an impact?

If there is excess liquidity it could come because the RBI is buying dollars (and printing rupees to buy them). There is no such buying at the moment.

The other, and more scary reason, is that banks aren’t willing to lend to the economy, or looking to find much safer borrowers. This is scary because what could be driving them to this situation could be high defaults, much of which we don’t know anything about.

If it’s the second reason we might be in a spot of trouble.

However it does mean that rates are down in the system; the safest avenues are seeing lower and lower yields.

With market rates coming down, we might see RBI rates fall in the next meeting, if inflation behaves. As the crude price goes below $90 it might be that inflation starts coming down overall; and if CPI is within a meaningful range, RBI will cut rates in the December meeting.

  • Guest says:

    Even with high liquidity;
    Still the banks need minimum balance in accounts.
    Premature penalty is levied on withdrawal of FDs.

  • If RBI doesn’t do this, interest rates will fall – which is what everyone wants, right? Then why is RBI doing this? Or am I missing something?

  • The reasons for high liquidity are:
    1. RBI is consistently reducing SLR. Banks are left with more funds to lend but appetite for credit is not increasing.
    2. Oil marketing companies are not borrowing like before as crude prices fell.
    It is good if RBI reduces liquidity which will make the Rupee stronger and helps fight inflation. But a bad indicator for economic growth as there is no appetite for fresh credit (due to high rates).
    Liquidity will further increase when subsidies reduce. Fiscal deficit coming down will make Govt. borrow less. Lower commodity prices reduce import bill and trade deficit and the necessity to borrow. So RBI sucking out liquidity will be a temporary measure and cannot help for long. Same situation continuing will discourage savings as Banks reduce deposit rates.
    The best measure is to find ways to deploy these funds for good use either by reducing rate or boosting infra sector which need huge funds for longer duration. Or reduce the balance sheet size at RBI. Otherwise this is a just lever RBI plays (like a toy) and does no real value addition in the long run.