RBI
LIQUIDITY INFUSION: ECONOMY
NEWS: RBI
announces liquidity injection measures amounting to about ₹1.87 lakh cr
WHAT’S
IN THE NEWS?
The RBI has announced a liquidity
infusion through Open Market Operations and a USD/INR Buy/Sell Swap auction to
ease liquidity conditions in the banking system. This aims to support lending,
stabilize interest rates, and boost economic growth amidst ongoing liquidity
strains.
In Response to Tight
Liquidity Conditions in the Banking System
- RBI Liquidity
Infusion Measures:
- The
Reserve Bank of India (RBI) has announced a liquidity infusion initiative
to ease tight liquidity conditions.
- This
initiative involves two key actions: Open Market Operations (OMO) and a USD/INR
Buy/Sell Swap auction.
Background of the
Liquidity Strain
- Since November 2024,
liquidity conditions have become strained due to several factors:
- Tax
outflows have reduced the available cash in the banking system.
- Foreign
portfolio investor (FPI) withdrawals have led to capital outflows from
India.
- The
RBI’s interventions in the forex market to stabilize the rupee have also
drained liquidity.
- The measures
introduced are aimed at stabilizing the money supply and promoting
smoother credit flow within the economy.
Objectives of the
Liquidity Infusion
- Easing financial
constraints faced by banks.
- Supporting lending
by ensuring that credit flow remains uninterrupted.
- Stabilizing the
economic environment by promoting economic stability.
Understanding Open Market
Operations (OMO) and Dollar Currency Swaps
- Open Market
Operations (OMO):
- OMO
refers to the buying or selling of Government Securities (G-Secs) in the
open market by the RBI to manage liquidity and interest rates.
- When
RBI buys G-Secs, it increases the high-powered money, thereby boosting
liquidity. High-powered money includes reserves held by commercial banks
and currency with the public.
- When
RBI sells G-Secs, it reduces the money supply, thereby tightening
liquidity.
- USD/INR Buy/Sell
Swap Auction:
- A
USD/INR Buy/Sell Swap involves banks selling US dollars to the RBI,
agreeing to buy them back at a pre-determined rate.
- The
swap is conducted via an auction where banks quote swap rates (forward
premium or discount). The lowest bid is accepted first.
Reasons for the Need for
Liquidity Infusion
- Liquidity challenges
have emerged since November 2024 due to:
- Tax
outflows reducing available cash for banks.
- FPI
selling in Indian equities leading to capital outflows.
- RBI’s
forex market interventions, which have drained rupee liquidity.
Significance of the RBI's
Liquidity Infusion
- Eases Lending
Conditions:
- The
liquidity infusion ensures banks have sufficient liquidity, which in turn
facilitates improved credit flow to businesses and individuals.
- Stabilizes Interest
Rates:
- The
measures help in stabilizing interest rates, preventing sudden hikes in
borrowing costs, which can be detrimental to economic growth.
- Enhances Market
Confidence:
- The
infusion boosts confidence among investors and businesses, ensuring
smoother economic operations.
- Encourages Policy
Effectiveness:
- It
ensures that RBI’s rate cuts, such as repo rate cuts, are passed on to
borrowers, thereby fostering economic activity.
- Supports Economic
Growth:
- By ensuring
liquidity and supporting lending, the initiative boosts consumption and
investment, which are critical for economic growth.
Concerns and Risks of
Liquidity Infusion
- Excess
liquidity in the system may lead to inflationary pressures as demand
increases while supply remains limited.
- If
excess liquidity is not managed well, it could lead to a weakening of the
rupee due to the USD/INR swaps and other interventions.
- Uneven Liquidity
Distribution:
- Larger
banks may benefit more from the liquidity measures compared to smaller
financial institutions, leading to potential disparities in access to
credit.
Other Liquidity Measures
Used by RBI
- Liquidity
Adjustment Facility (LAF):
Uses Repo and Reverse Repo rates to manage short-term liquidity.
- Cash
Reserve Ratio (CRR):
Specifies the minimum cash reserves that banks must hold with the RBI.
- Statutory
Liquidity Ratio (SLR):
Determines the percentage of net demand and time liabilities (NDTL) that
banks must maintain in government securities.
- Bank
Rate: A
long-term borrowing rate that influences credit expansion.
- Credit
Rationing:
Restricting credit to certain sectors of the economy.
- Moral
Suasion:
Persuading banks to adhere to RBI guidelines.
- Selective
Credit Control (SCC):
Regulating credit to avoid speculative activities.
- Margin
Requirement:
Adjusting the collateral needed for loans to control lending practices.
Key Announcements in
Liquidity Infusion
- RBI
is set to buy government securities worth ₹1 lakh crore in two tranches
of ₹50,000 crore each on March 12 and March 18, 2025.
- USD/INR Buy-Sell
Swap Auction:
- A $10
billion (approx. ₹87,000 crore) swap will be conducted with a tenor of 36
months, scheduled for March 24, 2025.
- In
January 2025, a $5 billion dollar-rupee swap was conducted.
- In
February 2025, another $10 billion dollar-rupee swap was announced.
Objective and Impact of
the Announced Measures
- Addressing Liquidity
Crunch:
- The
measures aim to alleviate the liquidity challenges before the financial
year 2025 ends.
- Supporting Financial
Targets:
- The
liquidity infusion supports banks in meeting their financial targets and
ensuring sufficient liquidity.
- Ensuring Durable
Liquidity:
- The
measures ensure that the banking system has access to durable liquidity,
which is essential for long-term stability.
- The
liquidity measures are also aimed at stabilizing the rupee and boosting
forex reserves.
Monetary Policy Context
- The RBI recently cut
the repo rate by 25 basis points, signaling an effort to boost economic
activity by lowering borrowing costs.
Significance of the
Measures
- The liquidity
infusion plays a crucial role in ensuring banking stability, which impacts
currency value and forex reserves.
- It is expected to
support credit growth and contribute to broader economic stability,
ensuring that the economy remains on a stable growth path.
Source:
https://www.thehindubusinessline.com/money-and-banking/rbi-announces-liquidity-measures-of-rs-187-lakh-crore-to-ease-banking-system-tightness-with-omo-and-usdinr-swap-auctions/article69295204.ece