India’s apex bank to take out 1trln from the system

India’s Reserve Bank (RBI) is set to withdraw nearly one trillion rupees ($12.07 billion) from the banking system by temporarily increasing the mandatory reserve amount that banks need to keep with the central bank. This move is aimed at curbing inflation.

Earlier on the same day, the Monetary Policy Committee of India decided to maintain key policy rates at their current levels. However, RBI Governor Shaktikanta Das advised banks to maintain an additional cash reserve ratio (CRR) of 10% on any increase in deposits made between May 19 and July 28. This directive will be effective starting from the fortnight beginning on August 12.

Throughout August, there has been an excess of liquidity in India’s banking system, averaging around 2.5 trillion rupees, compared to 1.6 trillion rupees in July. This surplus has resulted in lower overnight borrowing and lending rates.

RBI’s latest measure also aims to counterbalance the liquidity introduced to the banking system due to the reintroduction of 2000-rupee denomination notes, as stated by Governor Das.

Governor Das assured that even after implementing this temporary measure, there will still be sufficient liquidity in the system to support the economy’s credit requirements.

The Reserve Bank plans to evaluate the effectiveness of this measure before September 8, ahead of India’s festive season when currency circulation typically increases, and banking liquidity tends to decline. This implies that banks will need to maintain the additional CRR for the upcoming fortnights, ending on August 25 and September 8.

Market analysts anticipate that interbank call money rates and the TREPS rate, which is the rate at which non-bank borrowers secure overnight funds, will begin to rise starting from Monday, as approximately half of the excess liquidity is expected to be withdrawn.

Some experts have pointed out that the immediate consequence of the RBI absorbing liquidity through the incremental CRR would be a slight tightening of money market rates for borrowers. This also means that banks might experience a minor impact on their lending margins.

The decision to impose the incremental CRR followed a situation where banks refrained from parking their funds with the central bank using variable rate reverse repo (VRRR) auctions.

Governor Das emphasised that the 14-day variable rate reverse repo auction would remain the primary tool for liquidity management. Additionally, shorter-duration VRRR auctions would be employed for fine-tuning purposes.