The overnight standing deposit facility (SDF) has displaced the reverse repo window as the banks' preferred method for storing extra cash within six months of the return to the Reserve Bank of India's (RBI's) new liquidity management framework.
 

The RBI made the decision to reinstate the updated liquidity management mechanism known in its February policy after consecutive waves of the Covid-19 outbreak subsided and economic conditions began to normalise. The switch from the fixed rate reverse repo to the 14-day variable rate reverse repo (VRRR) auction marked the beginning of the change. The daily average liquidity surplus has slowly decreased from Rs 8.5 trillion at its peak since the switch to normal liquidity operations. 

“The system liquidity surplus (adjusted for CRR build up) came marginally lower than our expectations led by slower pace of government spending and likely RBI forex sales to cap pace of rupee depreciation,” said Kotak Mahindra Bank in a note recently. According to the report, the average liquidity surplus dropped from Rs 2.78 trillion surplus the week before to Rs 2.3 trillion surplus last week.

The amount of money in circulation (CIC) increased from Rs. 28.81 trillion as of December 31, 2021 to Rs. 30.79 trillion as of July 1, 2022. A portion of the RBI's foreign currency holdings, which were down to $518 billion as of July 8 from $569 billion as of January 7, had been lost as a result of the RBI's fight against rupee devaluation. Both the dollar sales and the 50 basis point (bps) increase in the cash reserve ratio (CRR) to 4.5 percent have had an impact on rupee liquidity.

Ashutosh Khajuria, executive director and CFO of Federal Bank, said system liquidity has declined with an increase in the amount of currency in circulation and the spending on reserves from the RBI. "Over the past few months in particular, the SDF has been the preferred method of storing surplus liquidity, as banks can choose to do this at their own choice. There are less than VRRR (variable rates reverse repo) auctions happening now," he said. An increase in demand for credit is also a sign that an overnight SDF window is more suitable for banks than locking funds in those 14 days of the VRRR.

Some market participants believe that , even in the event that the RBI remains on the same course of liquidity normalisation, it must be mindful not to hinder the growth. Ajay Manglunia is the managing director and head for capital markets for debt of JM Financial, said apart of the other measures that there is a possibility that the RBI is also selling a small amount of G-Secs on the market.

"From now on", the RBI will try to maintain adequate liquidity, not excess and will attempt to avoid a scenario where the market is flooded with liquidity. There's still a chance to reduce liquidity, and the measures will be in place. The surplus by the end of September could be as high as the range of Rs 1-1.5 trillion." Manglunia said.

There is a rumor of tightening liquidity in the festive season that is about to kick into. Soumyajit Niyogi director of the core analytical team, India Ratings and Research explained that a significant portion of the withdrawals from liquidity is due to the outflows of equity markets and an increase in the current deficit in the account.

"The CIC has risen by approximately 10 trillion dollars from levels prior to the Covid crisis. In September-end the excess liquidity will be in the region of Rs 2 trillion. In October, however, due to the start of the holiday period, CIC could rise further with a fall in liquidity to below one percent of NDTL. This could cause anxiety," Niyogi said.