The Reserve Bank of India (RBI) recently released the Report of the Internal Working Group (IWG) to Review the Liquidity Management Framework. Liquidity management operations are the nuts and bolts of monetary policy and, therefore, it is important that the framework is robust.

The report rightly suggests the discontinuation of a 14-day variable rate repo/reverse repo (VRR/VRRR) as the main operation. Banks, as the IWG report observes, are reluctant to park surplus liquidity for this duration. In addition, it is hard to make a precise liquidity forecast for 14 days as government cash balances maintained with the RBI are intrinsically volatile. Currency movements are unpredictable too, though they have predictable seasonal patterns. The main operation conducted at a weekly interval instead of 14 days, combined with the fine-tuning operations of varying tenors as and when needed as recommended by the IWG, should help smooth liquidity management.

The IWG’s recommendation on the retention of the weighted average call rate (WACR) as the operating target is also appropriate. However, a reduction in the activity for the overnight call money segment, from where the WACR emerges, raises concern, as this decreases the central bank’s control over short-term interest rates.

Why has activity in the call money market declined? The width of the corridor is essentially a trade-off between volatility in short-term interest........

© The Financial Express