India’s Finance Ministry planning to start a special deposit window

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India’s Finance Ministry may start a special deposit window to end an unusual liquidity overhang at this time of the financial year, helping the central bank deploy a more cost-effective device to manage excess cash that entered the banking system in the aftermath of the currency note swap.

Ministry officials are slated to meet top bankers Friday to discuss the one-off mechanism, the chief executive of a private bank told ET. Banks now are carrying a surplus of about Rs 4.68 lakh crore on an average this month, official data, compiled by Edelweiss Fin showed. The last month in a financial year is typically cash-deficit.
“Banks are facing a problem of large surplus liquidity currently,” said Piyush Wadhwa, head of treasury at IDFC Bank. “Some of this liquidity shall go away because of demonetisation and seasonal factors. However, the markets will keenly await the central bank’s move on removing this liquidity, and the impact of such a move.”
The surging cash in the system, triggered by the government’s November 8 demonetization and subsequent deposits, makes Reserve Bank of India’s (RBI) liquidity management costly as it pays 6.25% to mop up surplus liquidity from the system through the repo window. Surplus funds have also sent overnight borrowing rates plunging 50-55 basis points below the policy rate – a range clearly beyond the RBI’s zone of comfort.
Traditionally, the RBI prefers the call rate with the band of +/-25 bps over the policy/repo rate, now at 6.25%.
Bond traders are now battling the problem of plenty. They anticipate probable central bank actions to suck out excess liquidity, disrupting market rates. They believe that the finance ministry may be in favour of a special deposit window, aimed at sucking out the excess cash that banks are parking with the RBI to earn 5.75%.
“Cash will not go out of the banking system easily,” said Soumyajit Niyogi, Associate Director Credit & Market Research, India Ratings & Research. “Inter-bank call rates are clearly not in RBI’s target zone now, which needs to be realigned with RBI’s stated objective. Markets look a bit apprehensive of RBI measures to curb the ample liquidity, as some measures could exert pressure on bond yields, distorting the market.”
If the RBI, for instance, conducts open market operations by selling sovereign debt to sucking out liquidity, bond yields would rise. This in turn would make the government’s borrowing programme expensive.
In addition, dollar inflows too will keep cash sloshing as the RBI may have to intervene to curb any sharp rise in the rupee by buying dollars.
“An element of uncertainty is slowly gaining momentum in the money markets, with overnight rates deviating from their normal trajectory,” said Ajay Manglunia, executive VP (fixed income) at Edelweiss Finance. “The scenario may change over a period of time, but the markets would like to know whether this cash surplus is permanent and would have a prolonged bearing on the rates.”

In its last bi-monthly monetary policy, the central bank said: “The RBI is committed to ensuring efficient and appropriate liquidity management with all the instruments at its command to ensure close alignment of the WACR (weighted average call rate) with the policy rate.”