Market participants said the central bank may have to deploy additional tools, such as a sell-buy dollar swaps and bond sales through open market operations (OMOs), along with more VRRRs to sterilise the large liquidity injection.
Strong participation in the VRRR auction to be conducted on Monday would indicate that the RBI’s effort to maintain neutral liquidity has achieved some success, they said.
“The easiest thing for the RBI to do is to allow all the $36 billion forward dollar positions to mature within a year,” said Emkay Global economist Madhavi Arora. “Extinguishing those positions using the current dollar inflows will also help absorb the rupee liquidity generated because of the FCNR inflows.”
Arora expects the central bank to use a blend of tools, including bond sales through OMOs and sell-buy dollar swaps to suck out rupees from the banking system.
She said the RBI’s liquidity management has been called upon because the total inflows from the special schemes at $136 billion is significantly more than the initially expected $80-90 billion. This means about $50 billion (about ₹5 lakh crore) of extra liquidity is generated, she noted.
OMO of bonds is not a straight-forward option for the RBI as extra supply of bonds could push yields higher and make the government borrowing programme more expensive.Arora said the central bank may choose to sell bonds in the three to five-year maturity, targeting the exact tenure for which liquidity is generated through the FCNR scheme.
Bankers said more VRRR auctions will also be needed to ensure that excess liquidity is managed for the medium term.
“We could see more auctions depending on how this one goes. The RBI has previously done a 90-day VRRR auction, which cannot be ruled out in the current circumstance,” said Alok Singh, head treasury at CSB Bank. “Overall, it is fair to assume that more reverse repo auctions are likely.”
For the first time, the RBI has given participants in Monday’s auction an option for the premature withdrawal of the amount lent in the VRRR.
Bankers said the option to take back liquidity lent is because liquidity could also tighten because of the advance tax outflows on September 15.
“Though liquidity is at record levels, it is not evenly spread because the FCNR inflows have come mostly from the large banks and a couple of foreign banks,” a senior executive at a public sector bank said. “This amount of liquidity, with only may be top 10 banks, means that it cannot be deployed efficiently.”
Indeed, even as short term rates and overnight call market rates have plummeted, the other end of the curve has not moved much. For example, one-year certificates of deposits are still quoting above 7.50%.
Bankers said the RBI will have to be nimble footed to ensure it deals with this liquidity glut because it comes at a time when global rates are going up and local inflation is likely to only increase.