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About Surplus liquidity


Recently, the net liquidity in the banking system in India increased to Rs 2.59 lakh crore on June 4, 2023. However, the surplus liquidity in the banking system is likely to decline to around Rs 1.5 lakh crore over the next few days from the current level of Rs 2.1 lakh crore.


GS III: Indian Economy

Dimensions of the Article:

  1. About Surplus liquidity
  2. Instruments of Monetary Policy

About Surplus liquidity

Surplus liquidity refers to a situation in which the inflow of cash into the banking system consistently exceeds the withdrawal of liquidity by the central bank. This surplus liquidity results in a higher amount of readily available cash in the banking system for short-term needs.

Causes of Increased Liquidity:
  • Advance tax and goods and services tax (GST) payments: Large tax payments made by businesses and individuals increase the liquidity in the banking system.
  • Deposit of withdrawn Rs 2,000 notes: When people deposit high-denomination currency notes that have been withdrawn from circulation, it adds to the liquidity.
  • Redemption of government bonds: When government bonds mature and investors redeem them, it leads to an increase in liquidity.
  • Higher government spending: Increased government spending injects more money into the economy, contributing to surplus liquidity.
  • Sale of dollars by the RBI: The central bank may sell dollars from its reserves to prevent the depreciation of the domestic currency, which increases liquidity in the banking system.
Impact of Increased Liquidity:
  • Increased levels of inflation: Surplus liquidity can potentially lead to higher inflation as there is more money available for spending.
  • Low interest rates: The presence of excess liquidity tends to keep interest rates low as banks have more funds to lend and competition for borrowers intensifies.
RBI’s Measures:
  • The Reserve Bank of India (RBI) closely monitors liquidity levels and takes appropriate measures if they deviate from its comfort range.
  • The RBI uses its Liquidity Adjustment Facility (LAF) to inject or absorb liquidity from the banking system through repo and reverse repo operations.
  • The RBI may also conduct 14-day variable rate repo and/or reverse repo operations to manage liquidity conditions. These operations involve short-term borrowing or lending of funds to banks at variable interest rates.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy.

  • Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
  • Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
  • Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
  • Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
  • Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
  • Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
  • Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
  • Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
  • Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.

-Source: Indian Express

May 2024