The Reserve Bank of India (RBI) on Friday effectively raised the policy rate by 40 basis points by introducing a standing deposit facility (SDF), through which it seeks to suck out excess liquidity in the system, but without offering any collateral to banks.
RBI will now use SDF as the floor rate for Liquidity Adjustment Facility (LAF) corridor, instead of the reverse repo, which was kept unchanged at 3.35%. Under the new facility, banks will be able to park their surplus money with RBI, but at a higher rate of 3.75%.
So far, RBI used three policy rates under the LAF corridor to manage its monetary policy operations, including the repo rate, at which it lends to banks, reverse repo rate or the rate at which it drains excess liquidity from banks, and the marginal standing facility (MSF) rate at which RBI supplies liquidity when conditions are challenging.
The introduction of this facility will help RBI normalize the width of the LAF corridor to pre-pandemic levels of 50 basis points, with the repo being the target rate. “It has now been decided to introduce the SDF as the floor of LAF corridor. This would provide symmetry to the operating framework of monetary policy by introducing a standing absorption facility at the bottom of LAF corridor, similar to the standing injection tool at the upper end of the corridor, namely the MSF. Thus, at both ends of LAF corridor, there will be standing facilities," Shaktikanta Das, governor, RBI, said.
RBI dropped its pledge to keep the policy loose “as long as necessary" for the first time since late 2019. “RBI will engage in a gradual and calibrated withdrawal of excess liquidity over a multi-year time frame in a non-disruptive manner, beginning this year. The objective is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of the monetary policy," it said.
Since last year, RBI has been absorbing excess liquidity via variable rate reverse repo (VRRR) auctions. It allowed banks to bid higher than the reverse repo rate, and pushed the weighted average call money rate close to 3.95%. In February, RBI said VRRR and variable rate repo of 14-day tenor will operate as the primary liquidity management tool. “With 80% surplus liquidity absorbed under VRRR at a rate closer to the repo rate of 4%, the SDF at 3.75% will improve returns on the balance liquidity placed by banks at a reverse repo rate of 3.35%," said Anil Gupta, vice president and co-group head, Icra Ltd.
