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RBI Announces Over US$21 Billion Liquidity Infusion 

Last updated on March 6th, 2025 Posted on March 6, 2025 by NEXT IAS Current Affairs Team  315

Syllabus: GS3/ Economy

In News

  • In response to tight liquidity conditions in the banking system, the Reserve Bank of India (RBI) has announced a liquidity infusion initiative using two Open Market Operations (OMOs) and a USD/INR Buy/Sell Swap auction.

Background

  • Liquidity conditions have been strained since November 2024 due to tax outflows, foreign portfolio investor (FPI) withdrawals, and RBI’s forex interventions. With banks facing a liquidity crunch, these measures seek to stabilize the money supply and promote smoother credit flow.
  • This move aims to ease financial constraints, support lending, and ensure economic stability.

About Open Market Operations (OMO) & Dollar Currency Swap

  • Open Market Operations (OMO): OMO refers to the buying or selling of Government Securities (G-Secs) in the open market to regulate liquidity and interest rates.
    • RBI buys G-Secs, increasing high-powered money, which boosts liquidity. High-powered money includes commercial bank reserves and currency held by the public.
    • RBI sells G-Secs, reducing money supply, tightening liquidity.
  • US Dollar-Indian Rupee Swap Auction: A USD/INR Buy/Sell Swap involves:
    • Banks selling US dollars to RBI now and agreeing to buy them back later at a pre-determined rate.
    • Conducted via auction, where banks quote swap rates (forward premium/discount), and the lowest bidder is accepted first.

Why is Liquidity Infusion Needed?

  • Since November 2024, liquidity challenges have emerged due to:
    • Tax outflows reducing cash availability in the banking system.
    • Significant FPI selling in Indian equities, leading to capital outflows.
    • RBI’s forex market interventions to stabilize the rupee, which drained rupee liquidity.

Significance of RBI’s Liquidity Infusion

  • Eases lending conditions for banks, improving credit flow.
  • Stabilizes interest rates, preventing sudden spikes in borrowing costs.
  • Enhances market confidence, reassuring investors and businesses.
  • Encourages policy effectiveness, ensuring rate cuts are passed on to borrowers.
  • Boosting economic growth by supporting consumption and investment.

Concerns and Risks

  • Inflationary pressures: Excess liquidity may push inflation higher.
  • Depreciation risk: Forex swaps could lead to rupee weakening if excess liquidity is not managed well.
  • Uneven liquidity distribution: Large banks may benefit more than smaller financial institutions.
Other Liquidity Measures Used by RBI
– Quantitative Tools (directly impacting money supply):
1. Liquidity Adjustment Facility (LAF): Repo & Reverse Repo to regulate short-term liquidity.
2. Cash Reserve Ratio (CRR): Minimum cash reserves banks must hold.
3. Statutory Liquidity Ratio (SLR): Percentage of net demand and time liabilities (NDTL) to be maintained in G-Secs.
4. Bank Rate: Long-term borrowing rate influencing credit expansion.
– Qualitative Tools (indirect regulation of credit flow):
1. Credit Rationing: Restricting lending to certain sectors.
2. Moral Suasion: Persuading banks to follow RBI guidelines.
3. Selective Credit Control (SCC): Controlling credit for speculative activities.
4. Margin Requirement: Adjusting the collateral needed for loans.

Source: ET

 
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