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RBI keen to dissuade banks from high recourse to LAF — MSBs to absorb FDI-induced liquidity

Our Bureau

Mumbai , April 5

AS the Reserve Bank of India releases the first set of market stabilisation bonds of Rs 5,000 crore tomorrow, the central bank expects lower amount of surplus funds to be absorbed through the LAF (liquidity adjustment facility) window. The recent introduction of the seven-day repo is also intended for the same.

Market stabilisation bonds are one of a kind instruments launched specifically to absorb the liquidity created in the financial system due to the dollar inflows.

According to RBI officials, with the recent introduction of the seven-day repo and dismantling of the one-day repo facility, the amounts absorbed through LAF should come down. However, they were wary to state any estimates on the optimum levels.

LAF should work as an instrument to absorb the residual liquidity in the system and be the last resort to deploy funds. Currently market players use it as the primary liquidity absorber and do not even find lending in the call money market attractive.

The central bank has indicated that it desires an element of volatility in the call money markets in order to make the market more attractive. The seven-day lock-in period in the repos will encourage more resources to enter the call money market and create some changes in the call rates.

Call rates have been predictably steady at 4.25-4.50 over the last several months. Banks have of late preferred to submit the excess liquidity to RBI at the repo rate of 4.5 per cent instead of lending in call at a lower rate.

It is expected that the market stabilisation bonds (6.18 per cent 2005 paper of Rs 5,000 crore to be floated on Tuesday) will be easily subscribed given the level of liquidity in the system.

This issuance is the first off the block; RBI is expected to float bonds worth Rs 60,000 crore in this fiscal. These securities are no different from the government securities and treasury bills currently in the market. The only difference will be in the end-use of these funds.

While normal G-secs floated through the government borrowing programme help meet the expenses of the government, the proceeds from the market stabilisation bonds will lie dormant in an RBI account in Nagpur. These funds will not be invested anywhere, neither in the domestic markets nor in the international ones since doing the former would defeat the purpose of stabilisation and the latter because Indian rupees cannot be invested overseas, explained Dr Rakesh Mohan, Deputy Governor, Reserve Bank of India at a press briefing on the new instruments.

"Market stabilisation bonds will be used to take away the enduring liquidity created due to the excess dollar inflows while the LAF window will be used to manage day-to-day liquidity," he added.

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