Liquidity framework needs to have more flexibility: RBI panel

MUMBAI: A panel set up by the Reserve Bank of India (RBI) has recommended that the central bank’s liquidity framework be made flexible enough to adapt to conditions when the system requires liquidity to be in surplus mode.

Under the current setup, system liquidity is required to be in a small deficit, which could be an impediment when surplus liquidity is essential. The panel has also asked RBI to institutionalise some of the ad hoc liquidity infusion measures the central bank has adopted over the past few months. This recommendation comes against the backdrop of the liquidity squeeze seen in the aftermath of the Infrastructure Leasing and Financial Services Ltd (IL&FS) crisis last year and the continuing liquidity mismatches faced by NBFCs, leading many of them to default on their loan repayment schedules. According to RBI data compiled by Bloomberg, system liquidity remained largely in deficit mode between October last year and May. The situation has improved since, with a liquidity surplus of ₹84,081 crore as of September 24 from a deficit of as much as ₹1.7 lakh crore as on December 26.

The formation of the internal working group was announced on June 6 to review the current liquidity management framework in order to simplify it and suggest measures to clearly communicate the objectives. The group’s report was put up on RBI’s website on Thursday.

The report said the current liquidity management framework should largely continue in its present form with a corridor system, with the overnight call money rate as the target rate.

It said the design of the corridor system, with the repo rate as the policy rate, would generally require system liquidity to be in a small deficit of about 0.25-0.5% of net demand and time liabilities or total deposits.

“However, if financial conditions warrant a situation of liquidity surplus, the framework could be used flexibly, with variable rate operations to ensure that the call money rate remains close to the policy repo rate. Thus, liquidity operations should take into consideration the prevailing conditions, based on which the required tools will be used to achieve the objectives of liquidity management framework,” it said.