RBI starts SDF to Raise Effective Policy Rate : Daily Current Affairs

Relevance: GS-2: Government policies and interventions for development in various sectors

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key Phrases: Reserve Bank of India, standing deposit facility, Liquidity Adjustment Facility, repo rate, Reverse repo, marginal standing facility, liquidity management, fixed rate reverse repo, variable rate reverse repo.

Why in News?

RBI will now use SDF as the floor rate for Liquidity Adjustment Facility (LAF) corridor, instead of the reverse repo, which was kept unchanged at 3.35%.

Context:

The Reserve Bank of India (RBI) on Friday effectively raised the policy rate by 40 basis points by introducing a standing deposit facility (SDF), through which it seeks to suck out excess liquidity in the system, but without offering any collateral to banks.
RBI will now use SDF as the floor rate for Liquidity Adjustment Facility (LAF) corridor, instead of the reverse repo, which was kept unchanged at 3.35%. Under the new facility, banks will be able to park their surplus money with RBI, but at a higher rate of 3.75%.
So far, RBI used three policy rates under the LAF corridor to manage its monetary policy operations, including
- The repo rate, at which it lends to banks,
- Reverse repo rate or the rate at which it drains excess liquidity from banks, and
- The marginal standing facility (MSF) rate at which RBI supplies liquidity when conditions are challenging.

Tool of RBI to Liquidity Management in Economy

Bank rate: The interest rate at which RBI lends long term funds to banks is referred to as the bank rate. However, presently RBI does not entirely control money supply via the bank rate. It uses Liquidity Adjustment Facility (LAF) – repo rate as one of the significant tools to establish control over money supply. Bank rate is used to prescribe penalty to the bank if it does not maintain the prescribed SLR or CRR.
Liquidity Adjustment Facility (LAF): RBI uses LAF as an instrument to adjust liquidity and money supply. The following types of LAF are:
- Repo rate: Repo rate is the rate at which banks borrow from RBI on a short-term basis against a repurchase agreement. Under this policy, banks are required to provide government securities as collateral and later buy them back after a pre-defined time.
- Reverse Repo rate: It is the reverse of repo rate, i.e., this is the rate RBI pays to banks in order to keep additional funds in RBI. It is linked to repo rate in the following way:
- Reverse Repo Rate = Repo Rate – 1
Marginal Standing Facility (MSF) Rate: MSF Rate is the penal rate at which the Central Bank lends money to banks, over the rate available under the rep policy. Banks availing MSF Rate can use a maximum of 1% of SLR securities. MSF Rate = Repo Rate + 1

Role of Standing Deposit Facility

The main purpose of SDF is to reduce the excess liquidity of Rs 8.5 lakh crore in the system, and control inflation.
In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF – an additional tool for absorbing liquidity without any collateral. By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. The SDF is also a financial stability tool in addition to its role in liquidity management.
The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

How this help RBI:

The introduction of this facility will help RBI normalize the width of the LAF corridor to pre-pandemic levels of 50 basis points, with the repo being the target rate. “It has now been decided to introduce the SDF as the floor of LAF corridor.
This would provide symmetry to the operating framework of monetary policy by introducing a standing absorption facility at the bottom of LAF corridor, similar to the standing injection tool at the upper end of the corridor, namely the MSF. Thus, at both ends of LAF corridor, there will be standing facilities," Shaktikanta Das, governor, RBI, said.
RBI dropped its pledge to keep the policy loose “as long as necessary" for the first time since late 2019. “RBI will engage in a gradual and calibrated withdrawal of excess liquidity over a multi-year time frame in a non-disruptive manner, beginning this year. The objective is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of the monetary policy.
Since last year, RBI has been absorbing excess liquidity via variable rate reverse repo (VRRR) auctions. It allowed banks to bid higher than the reverse repo rate, and pushed the weighted average call money rate close to 3.95%. In February, RBI said VRRR and variable rate repo of 14-day tenor will operate as the primary liquidity management tool. “With 80% surplus liquidity absorbed under VRRR at a rate closer to the repo rate of 4%, the SDF at 3.75% will improve returns on the balance liquidity placed by banks at a reverse repo rate of 3.35%.

Way Forward:

The “extraordinary” liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other operations of the RBI, have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system.
This has pushed up the retail inflation level in the system. “The RBI will engage in a gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner beginning this year,” RBI Governor Shaktikanta Das said

Source: Live-Mint

Mains Question:

Q. Discuss the various tool of RBI monetary policy to suck out excess liquidity from the Economy and maintain inflation under limit. Examine.