RBI returns to revised liquidity management framework

The Reserve Bank of India (RBI) on Friday announced resumption of operations under the revised liquidity management framework, in a sign that it is set to unwind the Covid-related relief measures announced in March 2020. The return to the revised framework will be done in a phased manner and the central bank will conduct a Rs 2-lakh-crore variable rate reverse repo auction on January 15 under the revised liquidity management framework.

“On a review of evolving liquidity and financial conditions, it has been decided to restore normal liquidity management operations in a phased manner,” the RBI said in a statement. On February 6, 2020, the RBI had announced a revised liquidity management framework that communicated the objectives and toolkit for liquidity management. The framework was suspended in the wake of the outbreak of Covid-19. The central bank had decided to make the window for fixed rate reverse repo and marginal standing facility operations available throughout the day. This was intended to provide eligible market participants with greater flexibility in their liquidity management.

In view of operational dislocations and the elevated level of health risks posed by the pandemic, the RBI had also truncated trading hours for various market segments with effect from April 7, 2020. Later, with the graded rollback of the lockdown and easing of restrictions on movement of people and functioning of offices, it restored trading hours for markets in a phased manner with effect from November 9, 2020.

Earlier, RBI executives have signalled their intent to roll back Covid-specific policies in the light of a gradual normalisation in economic activity. In the minutes of the December monetary policy committee meeting, RBI executive director Mridul Saggar had said liquidity, credit and monetary aggregates will need to be closely monitored with an eye on macro-financial stability, which could weaken when short-term borrowing costs fall below the operational policy rate. “If this results in persistence of negative real rates for too long, it can adversely affect savings, lend support to mispricing of financial asset prices and encourage excessive leveraging. As such, other policies outside the flexible inflation targeting framework, such as macroprudential and strengthening the instruments of sterilisation in view of surge in capital inflows in recent months may be needed to mitigate these risks,” he had written.

Some market participants have read these comments as a hint that there may be no more rate cuts anytime soon.

An RBI working paper also made a case for retaining the inflation target at 4% into the medium term, suggesting that exceptional measures to keep money cheap may be on their way out.