liquidity management - evolution & practices followed in india

8/7/2019 Liquidity Management - Evolution & Practices followed in India

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LIQUIDITY MANAGEMENT -EVOLUTION & PRACTICES

FOLLOWED IN INDIA


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Flow

How was Liquidity Managed through Direct

Instruments earlier

How the direct instruments were inadequatefor liquidity Management and how itmigrated to indirect instruments

How Liquidity Management is performedtoday? Status of Repo/Reverse Repo, LAF,

MSS (Market Stabilization Scheme), India

Millennium Deposits (IMDs) etc


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Monetary Policy Instruments

3

Administered interest rates

Reserve requirements

Selective credit control

Direct Instruments Indirect Instruments

Open Market Operations Reserve Bankcontrols money supply by buying and selling

government securities, or other instruments

Market Stabilisation Scheme (MSS)

Government of India datedsecurities/Treasury Bills are being issued to

absorb enduring surplus liquidity.

Liquidity Adjustment Facility (LAF)

Repo Auctions and

Reverse Repo Auctions,

Cash Reserve Ratio (CRR)

Minimum amount that commercial banksmust keep as cash reserves

LAF has emerged as the tool for both liquidity management and also as a signalling devise forinterest rate in the overnight market.


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Open Market Operations

RBI conducts OMO to absorb/inject the

Liquidity in the economy

Issue - Dated Government Securities/ T-Bills Absorption of liquidity

Buy - Dated Government Securities/ T-Bills

Injection of liquidity


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LAF Chronology of

developmentsIn 1998 the Committee on Banking SectorReforms (Narasimham Committee II)recommended the introduction of a LiquidityAdjustment Facility (LAF)

In April 1999, Interim Liquidity Adjustment

Facility (ILAF), Collateralised Lending Facility(CLF), Additional collateralised lending facility(ACLF) were provided

The transition from ILAF to a full-fledged LAFbegan in June 2000 and was undertaken in threestages

Introduction of Second LAF (SLAF) fromNovember 28, 2005


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Liquidity Adjustment Facility

(LAF) RBI conducts Repo/Reverse Repo auctions of

Dates Government Securities/ T-Bills to

manage Liquidity in short term Daily auctions, rates determined through bids

(or fixed)

Provides the informal corridor for call/noticemoney rates


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Advantages of LAF

Helped the transition from direct instruments of monetarycontrol to indirect instruments

Provided monetary authorities with greater flexibility indetermining both the quantum of adjustment as well as therates

Enabled the RBI to modulate the supply of funds on a dailybasis to meet day-to-day liquidity mismatches

Enabled the RBI to affect demand for funds through policy ratechanges

Helped stabilise short-term money market rates


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Features of the Revised Liquidity Adjustment Facility Scheme

1 Tenor-Repo/ Tenor-

Reverse Repo

7 days fixed rate repo conducted daily (1 day repo from November 1, 2004)1 day overnight

fixed rate Reverse Repo on week days only

2 Option RBI retains the option to conduct overnight repo or longer term repo at fixed rate orvariable rates depending on market conditions. RBI will have the discretion to change the

spread between repo and reverse repo

3 Participants Scheduled commercial banks (excluding RRBs) and Primary dealers having current account

and SGL account with RBI

4 RepoRate 4.50% (Monetary Policy review-October, 2004raised the Repo rate to 4.75%) @

5 Reverse Repo rate 150 basis points above Repo rate. (Monetary Policy Review October, 2004 reduced the

spread to 125 basis points) @

Therefore, Reverse repo rate is 4.75% + 1.25% = 6.00%

6 Bidding The bids will be submitted electronically through NDS Cut off time for submission of bids

is 10.30 AM Auction result will be announced by 12.00 Noon

7 B id size Minimum Rs. 5 crore and multiple of Rs. 5 crore

8 Eligible securities All SLR eligible transferable Government of India dated securities/Treasury bills

9 Type Repo will be conducted as Hold-in-custody type wherein the RBI will act as custodian for

the participants and hold the securities on their behalf in the Repo/Reverse repo

ConstituentsAccounts

@ Repo and Reverse Repo rates are revised by RBI from time to time.


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RBI receives the bids for LAF in the

morning. The Financial Market Committee meets

daily at 12.00 noon to assess the bids.

The actual amount of liquidity to be

absorbed or injected into the system isdetermined by the RBI after taking intoaccount the liquidity conditions in themarket, the interest rate situation and the

stance of policy. The rate of interest depends on the

quotes received in the bids.


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Liquidity Management in

FY 2009-10 In 2009-10 RBI managed liquidity through appropriate use of

OMO, MSS, LAF and a slew of special facilities with the focusprimarily being on price and financial stability.

H

ighlights of FY10: The inter-bank liquidity conditions remained in the surplus mode, with

average daily LAF absorption being around Rs 100,000 crore during 2009-10.

Liquidity conditions eased significantly during the first half of 2009-10,mainly reflecting the MSS unwinding and OMO.

RBI purchased government securities amounting to Rs 80,000 crore underthe OMO programme for the first half of 2009-10 to ensure smoothgovernment market borrowing.

It was decided to conduct only one LAF on a daily basis with effect from May6, 2009, and conduct the second LAF (SLAF) only on reporting Fridays


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RBI purchased government securities amounting to Rs 57,487crore through the auction route during the first half of 2009-10,

whereas MSS unwinding was placed at around Rs 70,000 croreover this period.

Following the CRR hike in February 2010, the surplus liquiditydeclined further. With a view to addressing the year endliquidity requirements, RBI conducted additional LAF

operations on March 30 and 31, 2010. The average daily liquidity absorption through the LAF

increased to Rs 57,150 crore in April 2010, mainly on account ofdecline in the cash balances of the Central Government.

On May 26, 2010, the Reserve Bank announced access to

additional liquidity to SCBs under the LAF (to the extent of upto 0.5 per cent of their NDTL) and the SLAF on a daily basis


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Outstandings under LAF, MSS and GoI Balance

(Apr 09 to Aug 10)


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In principle, effective coordination between the central bank, which formulatesmonetary policy, and the Government, which is responsible for fiscal policy, isrequired for achieving the common set of macroeconomic objectives.

In principle, effective coordination between the central bank, which formulatesmonetary policy, and the Government, which is responsible for fiscal policy, is

required for achieving the common set of macroeconomic objectives. The increasing market participation in the primary issuance of Government

securities, and the Reserve Banks predominant use ofOMO sales from itsportfolio of Government securities for absorbing the excess liquidity prevailingalmost continuously since 1998-99 resulted in a steady diminishing ofmarketable securities available on its own account. An important aspect ofOMOsince 1998-99 has been inclusion of Treasury Bills of varying maturities.

As external capital flows picked up, the Reserve Bank had to supplement theoutright OMO sales of Government securities with reversible absorptions underthe Liquidity Adjustment Facility (LAF), operative from June 2000, for sterilisingthe monetary impact of its accretion in net foreign currency assets. The LAFinstrument, which was introduced to manage liquidity only at the margin,therefore, became a tool for managing enduring liquidity and was losing itsefficacy as an instrument to manage short-term liquidity.


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Treasury Bills, the key short-term borrowing instrument of the CentralGovernment20 and a convenient risk-free short-term investmentavenue for the market, have served as an important tool of shorttermliquidity management for the Reserve Bank. However, up to the early1990s (especially from 1965 with a migration to the tap issuance

system), the Treasury Bills could not be operated as a monetaryinstrument with flexible rates for liquidity management through openmarket operations. Market participants displayed a tendency torediscount their initial subscriptions with the Reserve Bank whichresulted in the latter passively absorbing a large volume of Treasury Billsin addition to its holding ofad hoc Treasury Bills issued to refurbishGovernment balances. The absence of a market outside the Reserve

Bank for the Treasury Bills and the inflexibility in the discount rate from1974 limited the use of Treasury Bills as a monetary tool or an efficientmoney market instrument. Furthermore, quite often in the 1980s, thenominal discount rates dipped below the inflation rates implyingnegative real interest rates.


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The auctioning of 182-day Treasury Bills in 1986 followed by a switchover to a full-fledged auctioning system in issuances of all Treasury Billsby the early 1990s and the institutionalisation of a system of primarydealers realigned the discount rates of Treasury Bills to the market-determined rates. It also helped in the development of a Treasury Bill

market outside the Reserve Bank and facilitated the use of Treasury Billsas a monetary instrument to suitably manage short-term liquiditythrough open market operations. The underlying rationale fordeveloping the Treasury Bill instrument during this phase lay inproviding short-term funds to the Government at market-determinedrates which, through the emergence of market reference rate, wouldalso facilitate monetary policy operations. The issuances of Treasury Bills

were also modulated in the wake of extinguishing ad hoc Treasury Billsandthe need to adhere to the discipline required under the WMA, on theone hand, and the requirement of developing a proper risk-free short-term yield curve for the market under evolving liquidity conditions, onthe other. Since April 2004, the Treasury Bills have also been used forsterilising the monetary impact of capital flows under the MSS.


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The need to adhere to the discipline required under the WMA, on the one hand,and the requirement of developing a proper risk-free short-term yield curve forthe market under evolving liquidity conditions, on the other. Since April 2004,the Treasury Bills have also been used for sterilising the monetary impact ofcapital flows under the MSS.

The Reserve Bank examined alternate instruments for sterilisation in the wake ofpersistent capital flows and depletion of Government securities from itsportfolio. In this context, the Reserve Banks Working Group on Instruments onSterilisation (Chairperson: Usha Thorat) was in favour of revisiting the 1997agreement so that the Governments surpluses with the Reserve Bank are notautomatically invested and can remain as interest-free balances with theReserve Bank, thereby releasing the Government securities for furthersterilisation operations (RBI, 2003c). Accordingly, investment of the Central

Governments surplus cash balances in dated securities was discontinuedtemporarily from April 8, 2004. Subsequently, with the introduction of theMarket Stabilisation Scheme to absorb liquidity, investment of the Centressurplus cash balances in its own paper was partially restored in June 2004 with aceiling of Rs.10,000 crore (enhanced to Rs.20,000 crore in October 2004).


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Market Stabilisation Scheme

In pursuance of the recommendations of the Working Group onInstruments on Sterilisation, the MSS was introduced from April 1, 2004under a Memorandum of Understanding (MoU) between the CentralGovernment and the Reserve Bank. Under this scheme, injections ofprimary liquidity on account of any increases in the Reserve Banks netforeign assets (NFA) are absorbed by the issuances of CentralGovernment Treasury Bills and dated securities under MSS. The moneyraised under the MSS is held by the Government in a separateidentifiable cash account maintained and operated by the Reserve Bank,which would be appropriated only for the purpose of redemption and/orbuyback of issuances under MSS. Thus, the increases in the Reserve

Banks NFA are matched by accretion in Government balances underMSS, thereby driving down the net Reserve Bank credit to theGovernment and nullifying the monetary impact of an increase in theReserve Banks NFA. The operation of the MSS has emerged as a keyinstrument of sterilisation and has effectively curbed the burden on LAFoperations


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Market Stabilisation Scheme (MSS)

W

hy the need?

Objective of absorbing the liquidity of enduring nature usinginstruments other than LAF

Reserve Bank appointed a Working Group on Instruments ofSterilisation (Chairperson: Smt Usha Thorat).


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Market Stabilisation Scheme (MSS) -

What does it include?

Agreed that the Government would issue Treasury Bills and/or dated securities under theMSS in addition to the normal borrowing requirements

Proceeds of MSS to be held by the Government in a separate identifiable cash accountmaintained and operated by RBI

Amounts would be appropriated only for the redemption and / or buy back of the TreasuryBills and / or dated securities issued under the MSS

Government of India and RBI signed a Memorandum of Understanding (MoU) on March 25,2004 and made operational since April 2004

Securities issued by way of auctions by the Reserve Bank

Serviced like any other marketable government securities.

MSS securities are being treated as eligible securities for Statutory Liquidity Ratio (SLR),

repo and Liquidity Adjustment Facility (LAF).


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MSS - Merits

Considerably strengthened the Reserve Bank's ability toconduct exchange rate and monetary managementoperations.

Allowed absorption of surplus liquidity by instruments of

short term (91-day, 182-day and 364-day T-bills)

medium-term (dated Government securities) maturity.

Given the monetary authorities a greater degree offreedom in liquidity management during transitions inliquidity situation.


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India Millennium Deposits (IMDs)

IMDs were foreign currency denominated deposits issued by State Bank of India in2000, on advice of the Government of India.

It mobilised a sum of USD 5.5 billion for a tenor of five years.

IMD carried coupons rate

8.50 per cent - US dollar

7.85 per cent - Pound Sterling

6.85 per cent Euro

IMD subscription was limited to non-resident Indians, persons of Indian origin and

overseas corporate bodies.

The interest income earned on IMD exempted from tax

These IMDs matured on December 28-29, 2005


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India Millennium Deposits (IMDs)

Carried out to contain disequilibrium while retaining monetary policy stance with amedium-term objective.

Outflows on account of the redemptions were met by smooth arrangements workedout in this regard.

During December 27-29, 2005, RBI sold foreign exchange out of its foreign exchangereserves to State Bank of India (SBI) totaling nearly US$ 7.1 billion (Rs.32,000 crore)

The smooth redemption of the IMD liability of this size, bunched at a point of time,reflects the growing maturity of the financial markets and the strength of the liquiditymanagement system that has been put in place.

Generation of liquidity via IMDs enabled RBI to reduce monetised deficit by offloadingthe central government's dated securities in its portfolio to the market.


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Thank You!!

liquidity management - evolution & practices followed in india

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