India’s central bank isn’t done fighting inflation yet. On Friday, it announced a series of measures targeted at removing liquidity from the system. These include issuing three-year bonds and a ceiling on the amount of money banks can park with it every day. Since December 2006, the Reserve Bank of India has removed Rs27,000 crore of liquidity from the system.
Under an existing arrangement called market stabilization scheme (MSS), RBI absorbs liquidity by issuing short-term 182-days and 364-days treasury bills. Now, it will issue dated government bonds to absorb liquidity for a longer term. The first such auction of a three-year bond will be held on 6 March. A RBI release on Friday said it would take stock every Friday and may continue to float dated securities along with treasury bills to drain liquidity.
In a related move, RBI has also capped the amount of surplus money that banks can park with it daily at Rs3,000 crore. RBI absorbs excess money daily from the system at 6% and infuses money, when the banks need, at 7.5%. Over the past few days, banks have been parking between Rs20,000 crore and Rs25,000 crore with RBI. By restricting the amount banks can park with it, the central bank is encouraging them to look for other places where they can be parked.
“RBI wants to drain out liquidity for a longer period. It is telling banks to invest their surplus cash in dated government securities,” said a debt dealer who did not wish to be identified. RBI’s action will have an immediate impact on the yield of government securities. The yield on 10-year benchmark paper that closed at 7.93% can go up to as much as 8.25%, said Nitin Jain, chief of fixed income securities at I-Sec, a firm that sells government securities.
“Apart from raising CRR (cash reserve ratio) and directly tinkering with interest rates, RBI is doing every thing else to tighten liquidity,” said an executive with a Mumbai-based private sector bank who did not wish to be identified.
One factor that has resulted in the continuing rise of liquidity in the system is the central bank’s dollar purchases, targeted at ensuring that the rupee doesn’t strengthen too much. “By putting in place these measures, RBI has ensured that it can continue to buy dollars and prevent too much appreciation of the local currency without impacting the direction of interest rates,” said a foreign exchange dealer.