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The primary question in the days leading to the new monetary policy was whether the Reserve Bank of India would use a giant suction pump to deal with the excess liquidity flooding the Indian financial system. The resolution of the monetary policy committee even describes the situation as a “persistent large structural liquidity surplus following demonetization”.
The Indian central bank has chosen a more nuanced strategy. There has been no hike in the cash reserve ratio or introduction of a special deposit facility. However, at 25 basis points, the gap between the rate at which it will lend to and borrow money from banks is now at its lowest since the central bank began the liquidity adjustment facility in June 2000. This means that the term repo rate will replace the weighted call money rate as the operating target of liquidity management, as recommended by the Urjit Patel committee.
Maintaining such a narrow policy corridor in conditions of excess liquidity will undoubtedly test the people running operations at Mint Street.