RBI LIQUIDITY INJECTION: ECONOMY

RBI LIQUIDITY INJECTION: ECONOMY

NEWS: RBI unveils series of measures to inject ₹1.5 Trillion liquidity; markets see imminent rate cut

WHAT’S IN THE NEWS?

The Reserve Bank of India (RBI) has introduced liquidity-enhancing measures worth ₹1.5 trillion to address a severe liquidity crunch in the banking system, driven by regulatory tightening and high cash demand. These measures include Open Market Operations (OMOs), a 56-day Variable Rate Repo auction, and a $5 billion Dollar/Rupee Swap auction to stabilize forex markets and support banking liquidity.

1. Rising Liquidity Crunch in the Banking System

  • Liquidity Deficit Spike: The banking system’s liquidity deficit peaked at ₹2.39 trillion (average) in the fortnight ending January 24, 2025.
  • Factors Behind Liquidity Crunch:
  • Regulatory Tightening: Stricter banking norms, including Liquidity Coverage Ratio (LCR) requirements, restrict banks' ability to lend freely.
  • High Cash Demand: Increased withdrawals and currency leakage from the banking system reduce available liquidity.
  • Forex Market Intervention: RBI’s aggressive dollar sales to support the rupee have drained liquidity from banks.

2. RBI’s Liquidity-Enhancing Measures

A. Open Market Operations (OMO) – ₹60,000 Crore

  • What is OMO?
  • The RBI buys or sells government securities to manage liquidity in the banking system.
  • Buying securities injects liquidity, while selling securities drains liquidity.
  • Current OMO Plan:
  • RBI will purchase ₹60,000 crore worth of government bonds in three tranches:
      • ₹20,000 crore on January 30, 2025.
      • ₹20,000 crore on February 13, 2025.
      • ₹20,000 crore on February 20, 2025.
  • Expected Impact:
  • Lowers government bond yields, making borrowing cheaper.
  • Increases banking system liquidity, allowing banks to lend more.

B. 56-Day Variable Rate Repo Auction – ₹50,000 Crore

  • What is a Repo Auction?
  • A short-term liquidity tool where RBI lends money to banks in exchange for government securities as collateral.
  • Why Variable Rate?
  • Unlike a fixed-rate repo, the interest rate is determined through an auction process based on market demand.
  • Current Auction Details:
  • Scheduled for February 7, 2025.
  • Worth ₹50,000 crore.
  • Expected Impact:
  • Provides temporary relief to banks facing a liquidity shortfall.
  • Ensures short-term cash availability in the banking sector.

C. Dollar/Rupee Swap Auction – $5 Billion

  • What is a Dollar/Rupee Swap?
  • A forex market operation where RBI either buys or sells U.S. dollars in exchange for Indian rupees.
  • Types of Swaps:
      • Buy/Sell Swap: RBI buys dollars from banks and promises to sell them back later (adds rupee liquidity).
      • Sell/Buy Swap: RBI sells dollars and commits to buying them back later (absorbs rupee liquidity).
  • Current Swap Plan:
  • $5 billion auction scheduled for January 31, 2025.
  • Six-month tenure.
  • Objectives and Impact:
  • Injects rupee liquidity into the system by exchanging dollars with banks.
  • Helps stabilize the rupee, which depreciated from ₹83.75/$1 in October to ₹87/$1 in January.

3. Forex Market and Rupee Stability Challenges

  • RBI’s Forex Market Intervention:
  • Since October 2024, the RBI has sold $130 billion to defend the rupee from excessive depreciation.
  • Despite interventions, the rupee fell sharply from ₹83.75/$1 in October to ₹87/$1 in mid-January.
  • Liquidity Measures and Rupee Stabilization:
  • By infusing rupee liquidity through swaps and OMOs, RBI aims to reduce volatility in forex markets.
  • Supports confidence in the rupee while managing inflationary risks.

4. Market Expectations and Possibility of a Repo Rate Cut

  • Current Repo Rate Scenario:
  • RBI has kept the repo rate unchanged at 6.5% since February 2023.
  • Inflation concerns previously prevented a rate cut.
  • Why a Rate Cut is Expected on February 7, 2025?
  • Liquidity infusion signals RBI’s confidence in inflation management.
  • Addressing banking liquidity needs may warrant a lower policy rate.
  • Lower borrowing costs could boost economic growth amid liquidity constraints.

5. Challenges to OMO Effectiveness

  • Limited Bank Participation:
  • Banks may hesitate to use OMOs due to Liquidity Coverage Ratio (LCR) requirements under Basel III norms.
  • Who Benefits More?
  • Insurance Companies & Provident Funds: Gain from bond yield reductions but contribute less to banking liquidity.
  • Yield vs. Liquidity Problem:
  • OMOs lower government bond yields but do not always directly improve liquidity for banks.

Source: https://www.newindianexpress.com/business/2025/Jan/27/rbi-unveils-series-of-measures-to-inject-15-trillion-liquidity-markets-see-imminent-rate-cut