RBI may revise liquidity management framework, introduce longer-term buy-sell swaps: SBI

MUMBAI: The Reserve Bank of India (RBI) is likely to announce significant changes to its Liquidity Management Framework (LMF), according to a report by the State Bank of India (SBI).

These adjustments could include daily Variable Rate Repo (VRR) auctions as the first step, alongside innovative measures to balance liquidity needs and strengthen the banking system.

SBI said, "More changes in RBI Liquidity Management Framework likely...Daily VRR the first step...Such changes and frontloading next round of moves are smart and pragmatic by RBI...Delicate mix of temporary and permanent liquidity injection / withdrawal remains a work in progress".

The report also suggested that the RBI might introduce longer-term buy-sell swaps, spanning two to three years, to bolster foreign exchange reserves and release liquidity into the system. These measures could serve as a pragmatic approach to manage the delicate balance between temporary and permanent liquidity requirements.

Over the past few months, liquidity in the banking system has been under pressure, primarily due to volatile movements in government cash balances and interventions in the foreign exchange market. This persistent liquidity crunch has raised concerns as it has crossed the comfort zone for the banking sector.

To address this, the RBI has reverted to daily dynamic VRR auctions, which are seen as short-term liquidity injections aimed at countering fluctuations in government cash balances.

However, these transactions are also acting as a substitute for more permanent liquidity adjustments, such as those needed to offset currency leakage or the liquidity impact of RBI's forex interventions.

In a strategic move, the RBI has been selling foreign currency in the spot and non-deliverable forward (NDF) markets, while conducting short-term buy-sell swaps. This helps replace maturing forward positions and counter the durable liquidity drain caused by spot market interventions.

"To negate such, in a smart move RBI has started to sell in Spot and NDF forwards and then doing short term buy sell swaps to replace the maturing forward sale position and also to counter the durable liquidity drain from spot intervention" said the report.

The SBI report highlighted that these measures reflect a smart and proactive approach by the RBI to address the ongoing liquidity challenges. However, the long-term resolution of the liquidity conundrum remains a work in progress, with the central bank likely to frontload further moves in the coming months.

These initiatives signal the RBI's commitment to maintaining financial stability while adapting to the evolving economic environment.