Dollar deluge prompts ₹1 trillion OMO; enough liquidity tools, says RBI governor
The Reserve Bank of India on Friday moved to drain the banking system’s dollar deluge from the runaway success of its special foreign deposit scheme, announcing plans to drain ₹1 trillion through open market bond sales. The central bank said it will sell sovereign securities across three tranches —offering ₹50,000 crore on 17 September, followed by two offerings of ₹25,000 crore each on 21 and 28 September.
The announcement comes after system liquidity crossed ₹11 trillion earlier this month, with RBI’s special window for foreign currency non-resident deposit (FCNR-B) deposits attracting $172.2 billion in just two months. This prompted the central bank to withdraw surplus liquidity of over ₹8 trillion through multiple variable rate reverse repo (VRRR) auctions. Currently, system liquidity is estimated to be at a surplus of ₹10.4 trillion.
The announcement came hours after governor Sanjay Malhotra told CNBC-TV18 that the RBI “enough tools” beyond VRRR to manage liquidity, such as open market operations (OMOs) and swaps. “We will deploy the tools that we think would be most appropriate. It could also be a combination of tools.”
Liquidity surplus
The central bank’s target has always been to maintain adequate or appropriate liquidity so that the operating target of weighted average call rate (WACR) aligns with the repo rate, Malhotra said. “That is going to be our goal right now. You can see that it (WACR) is low because of excess liquidity. That liquidity has to be withdrawn.” The WACR for 11 September was 5.02%, lower than the current repo rate of 5.25%.
Some of this liquidity will be withdrawn on its own “over a period of time”, he said, given the need to support the foreign exchange market and as reserve requirements of banks go up owing to robust credit growth. Total bank credit rose 18.6% on year to ₹226 trillion as of 15 August, as per latest data by the RBI.
Asked if hiking cash reserve ratio (CRR) requirements for banks is also on the table, Malhotra said that “nothing is off the table” and that RBI is conscious of the fact that CRR requirements had been done away with for FCNR deposits. “We will be conscious of that fact, and we will obviously not have a higher CRR or CRR in some other form on those deposits.” Banks currently need to park 3% of their deposits as CRR with the RBI.
Cost for RBI
The FCNR rush was significantly due to the fact that RBI decided to absorb the entire forex hedging cost for such deposits on behalf of banks. While the dollar deluge has raised concerns of higher costs for the central bank, Malhotra, disagreed.
“I don’t see it as a cost. Some people are saying it’s a cost, etc. but we need to look at the balance sheet of the whole country of India, not at the balance sheet only of RBI. It’s not a cost in terms of an expenditure that RBI is actually doing,” he said, adding that net-net, it will only result in additional revenues and income for RBI because any additional forex capital flows can be deployed in government securities abroad and earn interest.
“Some people are comparing it with the benchmark three-year forward premium. I don’t think that’s the right way to do it. That’s not the right price,” he said, adding that because the market there is very thin with few trades over the course of a year, it does not reflect the premium for such deposits. As per rates on forward premiums, analysts have pegged RBI’s hedging cost at 2.8-3.5% amounting to a total burden of ₹10-12 trillion.
“I think it was fairly priced, and it was important from the perspective of the Indian economy and the external sector resilience,” he said, adding that on its part, RBI discussed the scheme with stakeholders and banks prior to its launch. About 48-50% of the flows were for 5-year deposits, around 42% for 3-4-year deposits and the remaining about 9% or so were under the 4-5-year window, he said.
As such, flows under the scheme have been “very robust” and reflect overseas investors’ confidence in the “extremely strong macroeconomic fundamentals” of India. “It demonstrates at the same time that we can get foreign flows, capital flows, in a short period of time,” he said, adding that the flows will help the country in terms of financial stability and external sector resilience. “We are quite happy with the result.”
Revolving credit norms
On the recent draft norms barring non-bank entities from giving revolving credit, Malhotra said it was never the central bank’s intention to allow NBFCs to offer such products, adding the draft proposal reiterates this stance. The issue was flagged to NBFCs during RBI’s annual supervisory process, he said.
In a draft circular released on 6 August, the RBI proposed to limit NBFC lending strictly to term loans, effectively barring them from offering revolving credit facilities such as flexi-loans. The central bank introduced these guidelines to mitigate systemic stability risks, prevent loan evergreening, and address NBFCs’ liquidity vulnerabilities. Malhotra, however, stressed that the RBI is considering stakeholder feedback and that the final norms could differ.
As part of their feedback, NBFCs, through industry bodies, have sought clarity from RBI on the definition of revolving credit and exemptions for certain micro, small, and medium enterprise (MSME)-focused products, including supply-chain finance and invoice discounting. The lenders have also pleaded with the regulator to allow revolving credit facilities, albeit with tighter underwriting and disclosures to address any concerns, or issue a new framework for such loan products, Mint reported on 2 September.
In the interview, Malhotra said the share of such loans is currently low, but a sharp increase could raise issues related to systemic stability and liquidity, as they lack the liquidity support banks have and could eventually impact financial stability.
