RBI targets short-term liquidity to curb rupee volatility

RBI targets short-term liquidity to curb rupee volatilityIn a bid to curb drastic volatility in rupee, the Reserve Bank of India (RBI) on Monday targeted short-term rupee liquidity, saying cheap liquidity was one of the main causes for the rupee hitting record lows against the U. S. dollar.

The central bank said that it was providing banks with funds at 7.25 per cent (repo rate) from the liquidity adjustment facility (LAF). The central bank now restricted the amount that banks can borrow from the LAF window to 1 per cent of their deposits or net demand & time liabilities (NDTL).

The RBI said in a statement, “The exchange rate pressure also evidences that the demand for the foreign currency has increased vis-à-vis that of the rupee in part because of the improving domestic liquidity situation.”

The RBI also hiked the rate of marginal standing facility (MSF) by 200 basis points (bps). The MSF rate, an emergency funding facility window that banks can access when they fail to obtain funds from the LAF, was previously at 8.25 per cent. But with the hike in this rate, banks can now access these funds at 300 basis points above the repo rate, i. e. at 10.25 per cent.

The apex bank said that countries with huge current account deficit (CAD) like India were suffering because of market perception of likely rolling back of U. S. quantitative easing program despite their own comparatively stronger economies.

Since U. S. Federal Reserve’s May statement about the possibility of rolling back of quantitative easing program, the Indian currency has depreciated by 8 per cent. It hit its lowest level of 61.21 per dollar in early last week.

Meanwhile, as part of its efforts to suck out some of the extra liquidity, the RBI is also preparing to conduct an open market operation sale auction worth Rs 12,000 crore on 18th of July.