Eye on inflation, RBI goes after liquidity with Standing Deposit Facility

“In the sequence of priorities, we have now put inflation before growth,” said Shaktikanta Das, governor of Reserve Bank of India (RBI), in his opening remarks at the post monetary policy press conference today. The monetary policy announcements on Friday saw the central bank changing its policy stance as the world transitions from the pandemic-induced economic disruptions to those created by the Russia-Ukraine war. While the Monetary Policy Committee unanimously voted to retain the key policy rates – repo rate at 4% and reverse repo rate at 3.35% – Das made clear RBI’s intentions to adopt a “less accommodative” stance in future.

Indications are clear: RBI is preparing the ground to reverse the liquidity measures implemented during the pandemic, and subsequently halt the worrisome rise of retail inflation. And the tool of choice employed to achieve this two-pronged objective is the Standing Deposit Facility.

Standing Deposit Facility, or SDF, has been operationalised by the RBI with immediate effect from today at a rate of 3.75%. It will replace Fixed Rate Reverse Repo (FRRR) to join repo rate and Marginal Standing Facility (MSF) in the Liquidity Adjustment Facility (LAF) corridor. While MSF will help inject liquidity in the system, SDF will be used to absorb excess liquidity.

“By removing the binding collateral constraint on the central bank, the SDF strengthens the operating framework of monetary policy. The SDF as the floor of the LAF corridor would provide symmetry to the operating framework of monetary policy by introducing a standing absorption facility at the bottom of the LAF corridor, similar to the standing injection tool at the upper end of the corridor, namely the Marginal Standing Facility. Thus, at both ends of the LAF corridor, there will be standing facilities – one to absorb and the other to inject liquidity,” RBI said in its monetary policy report.

“Liquidity management will effectively be done with LAF, which has three rates – the MSF, the SDF and the repo [rate], with the repo at the centre,” said RBI deputy governor Michael D. Patra during the presser.

The reverse repo rate will not be in everyday use for liquidity management, but will remain a part of RBI’s toolkit to be used at the central bank’s discretion, Patra added.

SDF rate will be available to all LAF participants, who can place deposits with the RBI on an overnight basis. The RBI also retains the flexibility to absorb liquidity for longer tenors under the SDF with appropriate pricing, as and when the need arises. The overnight SDF facility will be available between 17:30 hrs to 23:59 hrs on all days, including Sundays and holidays, and would be reversed on the following working day in Mumbai.

Bids can be placed under SDF for a minimum of ₹1 crore and in multiples thereof, with no ceiling on the bid amount. Participants can set a maximum balance limit for their current accounts linked to SDF operations. At the end of the day, RBI’s e-Kuber system compares this limit with the participants’ current account balances after completion of all transactions, and auto-triggers SDF if it is greater than the set maximum balance.

The liquidity measures to spur growth in the wake of the pandemic had injected ₹8.5 lakh crore extra liquidity in the system. The central bank has been conducting variable rate reverse repo (VRRR) auctions to suck this extra liquidity out and ease inflationary pressure.

Das said RBI will now engage in gradual, multi-year withdrawal of this ₹8.5-lakh-crore liquidity overhang. And SDF could be an ideal tool for this long-term liquidity withdrawal.

“We had argued in our thought piece a quarter ago that time is ripe for SDF introduction, which would not only alleviate the collateral constraint but if effectively used, could have multiple benefits in policy flexibility on financial stability and for banking sector as well. The journey from current over ₹8 lakh crore system liquidity to a pre-Covid ₹2 lakh crore will be a long-drawn one and new tools like SDF will be needed to manage durable liquidity/any idiosyncrasies amid collateral constraints under VRRRs,” says Madhavi Arora, lead economist at Emkay Global Financial Services.

The standing facility comes shortly after retail inflation reached an eight-month high of 6.07% in February, its second above RBI’s upper tolerance band of 6%. RBI has also revised its inflation projections for FY23 upwards to 5.7%, up from the earlier estimation of 4.5% in the face of rising commodity and crude oil prices.

“...on assumption of a normal monsoon during 2022 and average crude oil price, that is the Indian basket, at $100 per barrel, inflation is now projected at 5.7% in 2022-23 with Q1 at 6.3%, Q2 at 5%, Q3 at 5.4% and Q4 at 5.1%,” Das stated during the monetary policy announcement.

The MPC also revised India's GDP forecast for FY23 downward to 7.2% from the earlier projection of 7.8%. Das said the real GDP growth is expected to rise to 16.2% in Q1 FY23; 6.2% in Q2 FY23; 4.1% in Q3 FY23 and 4% in Q4 FY23.