Surplus liquidity in the banking system could prompt the RBI to deploy an incremental cash reserve ratio before raising interest rates.
Core liquidity may approach ₹10 trillion in the coming weeks as government spending increases ahead of the festive season.
Highlights
- RBI may consider an incremental cash reserve ratio (iCRR) to absorb excess banking liquidity.
- Under iCRR, banks could be required to park a larger portion of fresh deposits with the central bank.
- The measure could be used before the RBI resorts to increasing the policy repo rate.
- Expectations of a repo rate hike have risen after the latest MPC minutes were viewed as hawkish.
- Economists now see the October policy meeting as a possible window for rate action.
- Core or durable liquidity in the banking system could approach ₹10 trillion in the coming weeks.
- Overnight market rates have been trading below the repo rate despite RBI liquidity absorption operations.
The Reserve Bank of India (RBI) may consider using an incremental cash reserve ratio (iCRR) to absorb excess liquidity from the banking system before turning to a repo rate hike, according to a Business Standard report.
Under an iCRR mechanism, banks are required to keep an additional portion of incremental deposits with the RBI. Such a move can temporarily remove surplus funds from the banking system and help the central bank tighten monetary conditions without immediately increasing its key policy rate.
The possibility has emerged as liquidity in the banking system remains high. Core, or durable, liquidity is expected to increase further as government expenditure picks up ahead of the festive season. The report said core liquidity could approach ₹10 trillion in the coming weeks.
Excess liquidity can complicate monetary policy transmission because short-term market rates may remain below the RBI’s policy rate. Overnight benchmark rates, including the weighted average call rate (WACR) and the triparty repo (Treps) rate, have been trading below the repo rate.
The RBI has been conducting daily variable rate reverse repo (VRRR) auctions to absorb excess funds. However, VRRR operations are generally used to manage temporary or transient liquidity, while an iCRR could potentially address a larger increase in durable liquidity.
Meanwhile, expectations of a possible repo rate increase have strengthened following the release of the Monetary Policy Committee’s latest meeting minutes, which were interpreted as hawkish.
Economists are now considering the October monetary policy meeting as a possible window for a rate action. Earlier expectations had largely placed the possibility of a rate hike in the next financial year.
If the RBI decides to use iCRR first, it could allow the central bank to withdraw surplus liquidity and strengthen monetary transmission before deciding whether a higher repo rate is required to control inflationary pressures.
