The hidden aspects of monetary policy

livemint.com:

₹6.9 trillion in April 2022 to less than ₹2 trillion in February 2023. Since February 2023, RBI has kept the policy repo rate unchanged and core liquidity has largely been around same levels, yet the policy stance is the same. Now, with the repo rate near its 2018 peak and the liquidity condition near neutral, the policy stance of ‘withdrawal of accommodation’ has become irrelevant.

Since the market sees the policy stance and timing of its change as a material event, it requires an explanation from RBI to avoid unwanted confusion. Liquidity management, though not directly under purview of the monetary policy committee, has a significant impact on the monetary policy. Typically, a tightening monetary policy regime is facilitated by a tighter liquidity condition, while an easing monetary policy requires an easy liquidity condition.

In the liquidity management framework before the covid-19 pandemic, RBI used to conduct regular auctions of fixed rate repo and 14-day variable rate repos for banks to borrow from it, while managing the surplus liquidity condition tactically through need-based variable rate reverse repo auctions. A pre-scheduled liquidity window used to act as a source of stability in the money markets, keeping the overnight market rates mostly near the policy repo rate. This framework has been tweaked in recent times.

Over the past year, RBI has been relying on variable rate repo and variable rate reverse repo auctions to manage the day-to-day liquidity in the banking system. However, the quantum and timing of these auctions are determined tactically based on regular assessments of banking system liquidity by RBI. This has added friction in the liquidity management between the banking system and RBI.