Mint Explainer: Understanding how RBI’s measures will boost liquidity by ₹1.5 trillion, lead to rate cut

The Reserve Bank of India (RBI) announced a set of forex, money market and interest rate measures that will collectively infuse ₹1.5 trillion over time, amid a clamour for liquidity from bankers and money market participants.Mint explains the significance of these measures.

What has the RBI announced?

The RBI announced three measures to boost liquidity in the system.

Firstly, the central bank will purchase government securities (G-Secs) worth ₹60,000 crore through open market operations (OMOs) in three tranches of ₹20,000 crore each. Through this, the RBI will buy G-Secs from the open market and inject liquidity into the system. The OMO auctions will take place on 30 January, and 13 and 20 February.

It will also conduct a 56-day variable rate repo (VRR) auction of ₹50,000 crore on 7 February and a dollar-rupee sell swap auction of $5 billion for a tenor of six months on 31 January. Under the swap, the RBI will buy dollars from banks in exchange for rupees, which will be released into the system. After six months, the RBI will sell the dollars.

How will these measures help?

These measures are expected to cumulatively infuse liquidity worth ₹1.5 trillion into the system over a period of time. They will provide the much-needed durable liquidity that has been the biggest ask of bankers. However, it may not be enough to plug the liquidity gap of ₹3 trillion in the system.

While the RBI carried out secondary market OMOs last week, having a scheduled OMO calendar provides certainty to the market. The VRR auction aims to ensure sufficient liquidity to meet banks' needs till 31 March. The dollar-rupee swap could help to smoothen the impact of an upcoming near-maturing massive, short position of the RBI in the forward and spot FX market, economists said.

What was the liquidity like before the measures?

Banking system liquidity has been in a deficit of more than ₹1 trillion since mid-December 2024, after being in a surplus from July to November 24. The average liquidity deficit in the interbank market crossed ₹3.3 trillion last week, thanks to heavy goods and services tax outflows.

That said, the central bank has been intervening in the forex market to keep the rupee less volatile over the past two years. However, the local currency began depreciating sharply in September as foreign portfolio investors aggressively sold Indian stocks and scooped up dollars to send money home. Forex reserves fell by as much as $70 billion in a span of two months from the all-time high of $704.9 billion in late September.

While the RBI sold dollars in the market, it sucked out rupee liquidity from the system. This was further exacerbated by the slow government spending. While the RBI responded to the liquidity tightness since December with a cut in the cash reserve ratio (CRR) and daily VRRs in January, the liquidity deficit widened due to the sudden plunge in rupee. The CRR, which is the percentage of deposits that banks must keep with the RBI, was cut by 50 basis points.

Are these steps a precursor to a rate cut?

Bankers and economists said the RBI’s actions on liquidity are a clear signal of intent and set the stage for an interest rate cut. Injecting interbank liquidity is a precondition for policy transmission, they said.

Some of them expect a further cut of 50 basis points in the CRR. The RBI has scheduled the 56-day VRR on the day of the monetary policy announcement, also signalling the possibility of a rate cut. The next meeting of the Monetary Policy Committee is scheduled during 5-7 February 2025.

However, some analysts said a rate cut may be deferred as inflation continues to be closer to 5% and the rupee has been depreciating to record lows. They expect the RBI to assess the impact of US president Donald Trump's actions first before deciding on a rate cut.