Economy: Liquidity Revamp is not QE

//Economy: Liquidity Revamp is not QE

Economy: Liquidity Revamp is not QE

RBI’s liquidity revamp is not QE

Context :

Reserve Bank of India have cut lending rates by 25 basis points and have asked banks to pass on the rate cut benefits to the consumers.Some observers have described the Reserve Bank of India’s (RBI) revised liquidity management framework as quantitative easing (QE).

RBI Liquidity

VISION OF RBI

The new framework modernizes liquidity management by making it more market-based i.e. lowering down the rates and injecting more liquidity into market .

WHY HAS RBI DONE SO?

  1.  Complaints by banks that liquidity is too tight
  2. Need To Move From A Fixed Rate System To Floating Rate Regime ( to increase liquidity as per the needs of the economy)

NOTE:

Until a few years ago, if banks were in need of funds, it was done by banks borrowing at the central bank’s FIXED OVERNIGHT REPO window, if they were short, or by parking surplus liquidity at the lower FIXED OVERNIGHT REVERSE REPO window. But now  RBI relies on its DAILY MARKET-DRIVEN management in the LIQUIDITY ADJUSTMENT FACILITY (LAF), which is used to aid banks with their short-term liquidity mismatches.

Earlier, In order to encourage the use of term repos, RBI governor Raghuram Rajan had CAPPED liquidity injection at the overnight repo rate window while offering the balance via term repo auctions. The aim was that over time, banks would have to stop relying on RBI for liquidity support solely at the FIXED RATE WINDOW and INSTEAD adapt to FLOATING RATES at each auction.

     3. The availability now of variable rate reverse repo auctions also eliminates a pesky aspect of the earlier framework ; excess liquidity pushing the overnight rate away from the repo policy rate to the reverse repo rate, the lower end of the LAF corridor.

Why is the step not Quantitative easing?

To carry out QE central banks create money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence “quantitative” easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans. The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn boosts investment.

Here, in this case there is no excessive money creation, which is the hallmark of QE. RBI will inject liquidity (i.e. reserve money) as needed and then adjust the short-term liquidity to be consistent with its stance.

By | 2016-04-14T10:43:14+00:00 April 14th, 2016|Categories: GS Paper 3|Tags: , , , , , |0 Comments

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