The Hindu Business Line : Is it end of the road for reverse repo?

The Reserve Bank of India injects or removes liquidity every day from the market through repos and reverse repos. In a repo, the RBI lends funds while in a reverse repo it absorbs funds.

The rates at which these are done are the repo and reverse repo rates. Naturally, the repo rate is more than the reverse repo rate. Currently, they are 7.25 per cent and six per cent respectively.

In its semi-annual monetary policy review last month, the RBI increased the repo rate but did not touch the reverse repo rate. It is significant and could be the prelude to doing away with reverse repos altogether.

For, what, after all, is the reverse repo? Along with the repo, it was conceived of by the central bank to manage daily system liquidity. Those were the days of few avenues of money market investments. The reverse repo was a safe window for banks to park their surplus funds and earn a return.

Excess liquidity soon became endemic. An ultra-safe investment for ultra-conservative banks soon became the first line of defence against soft money markets. The more savvy banks even arbitraged between low market rates and the higher reverse repo rate to earn profits at the RBI's expense.

Different concern

The RBI's concern was different: inflation, stemming from excess liquidity, which, thinking on its feet, it decided to mop up with special bonds. The programme was effective. System liquidity, as reflected in the RBI's daily auctions, has dwindled from Rs 50,000 crore plus to about half of the amount, without sustained market volatility or impact on the real economy.

Of course, the scenario now is different. It is the repo rate that is hogging the limelight. Thankfully so far, for the RBI, market rates are below repo but not as much as to breach the reverse repo rate.

The question is whether the reverse repo has a role at all. A central bank must (rightfully) supply liquidity when market rates overshoot its benchmark. But there is no symmetrical obligation to protect the downside when rates are low. On the contrary, liquidity-constricting measures would be in order, lest the overhang risks price stability.

What matters to financial markets is the central bank-imposed price of liquidity and its availability at that price. The G-7 central banks guarantee liquidity support at or near their benchmarks against eligible collateral. It seems that the RBI is also veering around to this. Hence, perhaps, the downplaying of the reverse repo rate in the latest policy, paving the way for its abolition and a single benchmark rate.

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