Challenges of Surplus Liquidity – UPSC GS3

What are the reasons behind surplus liquidity in the system?
To stimulate growth, various tools were used by RBI during pre-Covid and Post Covid phase to push excess liquidity into the system. These tools are:
  • LTRO (long term repo operations)
  • OMO (open market operations)
  • TLTRO (targeted long-term repo operations)
  • GSAP (government securities acquisition programme)
  • RBI’s low repo rate
  • A low CRR (cash reserve ratio)
As a consequence, liquidity increased. Almost ₹6-8 trillion of surplus liquidity resides in RBI’s reverse repo window which remains unutilised.
Why excess liquidity was not utilized?
  • Demand was not strong, with low-capacity utilization rates in most sectors (60-69%) holding back investment.
  • Private investment in infrastructure hasn’t yet taken off.
  • While MSMEs borrowed on the back of the guarantee, the funds were used to repay loans and maintain business rather than for growth.
  • Banks were too picky in terms of new customers as they were busy getting bad loans off their books.
Why exiting the surplus liquidity is a challenge for RBI now?
  • While the RBI has stopped buying GSAP, it does not address the issue of surplus liquidity. Further, it is difficult for RBI to manipulate the reverse repo window tools as of now.
  • Banks are trying to stop deposits by keeping interest rates low. Although this can ensure that surpluses don’t increase, it doesn’t reduce them either.
  • Financial markets have not quite reacted positively to surpluses, as government bond yields remain high in relative terms.
What needs to be done to drain excess liquidity?
  • Bank credit demand must pick up, with the economy’s investment cycle turning around.
  • Centre should be borrowing more so that banks automatically channel their surpluses back.
  • RBI should be going in for some OMO sales to reverse its GSAP effort, so that these securities return to banks.
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