India’s topsy-turvy money market needs a remedial plan

livemint.com:

Bank of India (RBI) introduced an incremental cash reserve ratio (ICRR). About ₹1.1 trillion withdrawn through it turned the market around. From a state of surplus liquidity, the system now tends to be in a state of deficit on several days, exhibiting some curious tendencies.

To begin with, there has been a deficit caused by variance in the growth of bank deposits and credit. The latter has outpaced the former. As of 3 November, incremental deposits were ₹15.36 trillion (excluding the HDFC Bank merger), while growth in credit was ₹13.06 trillion and in investments, ₹5.9 trillion.

Hence, a direct deficit of around ₹3.6 trillion is visible. However, the quirky part of the market is that the liquidity status of banks differs. There are some with surplus liquidity, while others are in perennial deficit.

This is evidenced by frequent use of RBI’s marginal standing facility (MSF) window, through which money is provided on an overnight basis at a fixed rate of 6.75%. It reflects the liquidity strain. On the other hand, there are surpluses with some larger banks that are parked in the standing deposit facility (SDF) at a 6.25% return.

Then there are periodic variable rate reverse repo (V3R) auctions held by RBI in which the scheduled amount normally is ₹50,000 crore for, say, 14 days, but only a fraction of it is subscribed by banks. Banks are not too forthcoming with their investments at this window. The reason is that they do not want to lock-in their funds for a long tenure and prefer to use the SDF window, even though the return there is 6.25%, as against V3R’s 6.49%.