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` How was Liquidity Managed through Direct

Instruments earlier
` How the direct instruments were inadequate
for liquidity Management and how it
migrated to indirect instruments
` How Liquidity Management is performed
today? Status of Repo/Reverse Repo, LAF,
MSS (Market Stabilization Scheme), India
Millennium Deposits (IMDs) etc
Ú


 

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pen Market
perations Ȃ Reserve Bank
Administered interest rates controls money supply by buying and selling
government securities, or other instruments
Reserve requirements 
     
 Ȃ
Government of India dated
Selective credit control securities/Treasury Bills are being issued to
absorb enduring surplus liquidity.
    
   
Repo Auctions and
Reverse Repo Auctions,
 
  
Minimum amount that commercial banks
must keep as cash reserves

 

  
   
 
          



 
 

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£
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` RBI conducts
M
to absorb/inject the

Liquidity in the economy
` Issue - Dated Government Securities/ T-Bills Ȃ
Absorption of liquidity
` Buy - Dated Government Securities/ T-Bills Ȃ
Injection of liquidity
 m ÷ 






In 1998 the Committee on Banking Sector
Reforms (Narasimham Committee II)
recommended the introduction of a Liquidity
Adjustment Facility (LAF)

In April 1999, Interim Liquidity Adjustment

Facility (ILAF), Collateralised Lending Facility
(CLF), Additional collateralised lending facility
(ACLF) were provided

The transition from ILAF to a full-fledged LAF

began in June 2000 and was undertaken in three
stages

Introduction of Second LAF (SLAF) from

November 28, 2005
 m  ÷ 
m ÷
` RBI conducts Repo/Reverse Repo auctions of
Dates Government Securities/ T-Bills to
manage Liquidity in short term
` Daily auctions, rates determined through bids
(or fixed)
` Provides the informal corridor for call/notice
money rates
 
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elped the transition from direct instruments of monetary
control to indirect instruments

Provided monetary authorities with greater flexibility in

determining both the quantum of adjustment as well as the
rates

Enabled the RBI to modulate the supply of funds on a daily

basis to meet day-to-day liquidity mismatches

Enabled the RBI to affect demand for funds through policy rate
changes

elped stabilise short-term money market rates

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` RBI receives the bids for LAF in the
morning.
` The Financial Market Committee meets
daily at 12.00 noon to assess the bids.
` The actual amount of liquidity to be
absorbed or injected into the system is
determined by the RBI after taking into
account the liquidity conditions in the
market, the interest rate situation and the
stance of policy.
` The rate of interest depends on the
quotes received in the bids.
 m Ú 
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` In 2009-10 RBI managed liquidity through appropriate use of

M
, MSS, LAF and a slew of special facilities with the focus
primarily being on price and financial stability.
ighlights of FY10:
` The inter-bank liquidity conditions remained in the surplus mode, with
average daily LAF absorption being around Rs 100,000 crore during 2009-10.
` Liquidity conditions eased significantly during the first half of 2009-10,
mainly reflecting the MSS unwinding and
M
.
` RBI purchased government securities amounting to Rs 80,000 crore under
the
M
programme for the first half of 2009-10 to ensure smooth
government market borrowing.
` It was decided to conduct only one LAF on a daily basis with effect from May
6, 2009, and conduct the second LAF (SLAF) only on reporting Fridays
` RBI purchased government securities amounting to Rs 57,487
crore through the auction route during the first half of 2009-10,
whereas MSS unwinding was placed at around Rs 70,000 crore
over this period.
` Following the CRR hike in February 2010, the surplus liquidity
declined further. With a view to addressing the year end
liquidity requirements, RBI conducted additional LAF
operations on March £0 and £1, 2010.
` The average daily liquidity absorption through the LAF
increased to Rs 57,150 crore in April 2010, mainly on account of
decline in the cash balances of the Central Government.
`
n May 26, 2010, the Reserve Bank announced access to
additional liquidity to SCBs under the LAF (to the extent of up
to 0.5 per cent of their NDTL) and the SLAF on a daily basis
?  m ÷# Ú

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` In principle, effective coordination between the central bank, which formulates
monetary policy, and the Government, which is responsible for fiscal policy, is
required for achieving the common set of macroeconomic objectives.
` In principle, effective coordination between the central bank, which formulates
monetary policy, and the Government, which is responsible for fiscal policy, is
required for achieving the common set of macroeconomic objectives.
` The increasing market participation in the primary issuance of Government
securities, and the Reserve Bankǯs predominant use of
M
sales from its
portfolio of Government securities for absorbing the excess liquidity prevailing
almost continuously since 1998-99 resulted in a steady diminishing of
marketable securities available on its own account. An important aspect of
M

since 1998-99 has been inclusion of Treasury Bills of varying maturities.
` As external capital flows picked up, the Reserve Bank had to supplement the
outright
M
sales of Government securities with reversible absorptions under
the Liquidity Adjustment Facility (LAF), operative from June 2000, for sterilising
the monetary impact of its accretion in net foreign currency assets. The LAF
instrument, which was introduced to manage liquidity only at the margin,
therefore, became a tool for managing enduring liquidity and was losing its
efficacy as an instrument to manage short-term liquidity.
` Treasury Bills, the key short-term borrowing instrument of the Central
Government20 and a convenient risk-free short-term investment
avenue for the market, have served as an important tool of shortterm
liquidity management for the Reserve Bank. However, up to the early
1990s (especially from 1965 with a migration to the tap issuance
system), the Treasury Bills could not be operated as a monetary
instrument with flexible rates for liquidity management through open
market operations. Market participants displayed a tendency to
rediscount their initial subscriptions with the Reserve Bank which
resulted in the latter passively absorbing a large volume of Treasury Bills
in addition to its holding of Treasury Bills issued to refurbish
Government balances. The absence of a market outside the Reserve
Bank for the Treasury Bills and the inflexibility in the discount rate from
1974 limited the use of Treasury Bills as a monetary tool or an efficient
money market instrument. Furthermore, quite often in the 1980s, the
nominal discount rates dipped below the inflation rates implying
negative real interest rates.
` The auctioning of 182-day Treasury Bills in 1986 followed by a switch
over to a full-fledged auctioning system in issuances of all Treasury Bills
by the early 1990s and the institutionalisation of a system of primary
dealers realigned the discount rates of Treasury Bills to the market-
determined rates. It also helped in the development of a Treasury Bill
market outside the Reserve Bank and facilitated the use of Treasury Bills
as a monetary instrument to suitably manage short-term liquidity
through open market operations. The underlying rationale for
developing the Treasury Bill instrument during this phase lay in
providing short-term funds to the Government at market-determined
rates which, through the emergence of market reference rate, would
also facilitate monetary policy operations. The issuances of Treasury Bills
were also modulated in the wake of extinguishing "
 
# 
the need to adhere to the discipline required under the WMA, on the
one hand, and the requirement of developing a proper risk-free short-
term yield curve for the market under evolving liquidity conditions, on
the other. Since April 2004, the Treasury Bills have also been used for
sterilising the monetary impact of capital flows under the MSS.
` The need to adhere to the discipline required under the WMA, on the one hand,
and the requirement of developing a proper risk-free short-term yield curve for
the market under evolving liquidity conditions, on the other. Since April 2004,
the Treasury Bills have also been used for sterilising the monetary impact of
capital flows under the MSS.
` The Reserve Bank examined alternate instruments for sterilisation in the wake of
persistent capital flows and depletion of Government securities from its
portfolio. In this context, the Reserve Bankǯs Working Group on Instruments on
Sterilisation (Chairperson: Usha Thorat) was in favour of revisiting the 1997
agreement so that the Governmentǯs surpluses with the Reserve Bank are not
automatically invested and can remain as interest-free balances with the
Reserve Bank, thereby releasing the Government securities for further
sterilisation operations (RBI, 200£c). Accordingly, investment of the Central
Governmentǯs surplus cash balances in dated securities was discontinued
temporarily from April 8, 2004. Subsequently, with the introduction of the
Market Stabilisation Scheme to absorb liquidity, investment of the Centreǯs
surplus cash balances in its own paper was partially restored in June 2004 with a
ceiling of Rs.10,000 crore (enhanced to Rs.20,000 crore in
ctober 2004).
` 
     

` In pursuance of the recommendations of the Working Group on
Instruments on Sterilisation, the MSS was introduced from April 1, 2004
under a Memorandum of Understanding (MoU) between the Central
Government and the Reserve Bank. Under this scheme, injections of
primary liquidity on account of any increases in the Reserve Bankǯs net
foreign assets (NFA) are absorbed by the issuances of Central
Government Treasury Bills and dated securities under MSS. The money
raised under the MSS is held by the Government in a separate
identifiable cash account maintained and operated by the Reserve Bank,
which would be appropriated only for the purpose of redemption and/or
buyback of issuances under MSS. Thus, the increases in the Reserve
Bankǯs NFA are matched by accretion in Government balances under
MSS, thereby driving down the net Reserve Bank credit to the
Government and nullifying the monetary impact of an increase in the
Reserve Bankǯs NFA. The operation of the MSS has emerged as a key
instrument of sterilisation and has effectively curbed the burden on LAF
operations
 !"#$%
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bjective of absorbing the liquidity of enduring nature using

instruments other than LAF

Reserve Bank appointed a Working Group on Instruments of

Sterilisation (Chairperson: Smt Usha Thorat).
  !"#$%
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Agreed that the Government would issue Treasury Bills and/or dated securities under the
MSS in addition to the normal borrowing requirements

Proceeds of MSS to be held by the Government in a separate identifiable cash account

maintained and operated by RBI

Amounts would be appropriated only for the redemption and / or buy back of the Treasury
Bills and / or dated securities issued under the MSS

Government of India and RBI signed a Memorandum of Understanding (MoU) on March 25,
2004 and made operational since April 2004

Securities issued by way of auctions by the Reserve Bank

Serviced like any other marketable government securities.

MSS securities are being treated as eligible securities for Statutory Liquidity Ratio (SLR),
repo and Liquidity Adjustment Facility (LAF).
Ú

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Considerably strengthened the Reserve Bank's ability to

conduct exchange rate and monetary management
operations.

Allowed absorption of surplus liquidity by instruments of

short term (91-day, 182-day and £64-day T-bills)
medium-term (dated Government securities) maturity.

Given the monetary authorities a greater degree of

freedom in liquidity management during transitions in
liquidity situation.
  Ú  )
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IMDs were foreign currency denominated deposits issued by State Bank of India in
2000, on advice of the Government of India.

It mobilised a sum of USD 5.5 billion for a tenor of five years.

IMD carried coupons rate

8.50 per cent - US dollar

7.85 per cent - Pound Sterling
6.85 per cent Ȃ Euro

IMD subscription was limited to non-resident Indians, persons of Indian origin and
overseas corporate bodies.

The interest income earned on IMD exempted from tax

These IMDs matured on December 28-29, 2005

  Ú  )
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Carried out to contain disequilibrium while retaining monetary policy stance with a
medium-term objective.

utflows on account of the redemptions were met by smooth arrangements worked

out in this regard.

During December 27-29, 2005, RBI sold foreign exchange out of its foreign exchange
reserves to State Bank of India (SBI) totaling nearly US$ 7.1 billion (Rs.£2,000 crore)

The smooth redemption of the IMD liability of this size, bunched at a point of time,
reflects the growing maturity of the financial markets and the strength of the liquidity
management system that has been put in place.

Generation of liquidity via IMDs enabled RBI to reduce monetised deficit by offloading
the central government's dated securities in its portfolio to the market.
Thank You!!