RBI will hold another Open Market Operation (OMO) to buy government bonds worth upto Rs. 10,000 crore on Wednesday because, it seems, the liquidity situation has gotten tight again. While call rates are only at 8.89% (which is not that much stress) it appears that cash balances at the government account with the RBI could be at a  high, and that takes away from liquidity. But that doesn’t add up, according to RBI’s own data – the government balances as of Jan 10, 2014 are just 7,900 cr. which is not really very high in the scheme of things:

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But they will soon receive nearly 20,000 cr. from the Coal India dividend, and Rs. 5,000 cr. from the IOC inter-government company sale. That’s 25,000 cr. out into the government account at the RBI. Now the government has curtailed expenditure so they might not need to spend this just yet, so the money remains within the RBI, which means it’s not available to others to use. Hence, an OMO so that the banking system isn’t strained, because they’ve already been borrowing a heck of a lot.

Here’s how much the banks have been borrowing from RBI short term:

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We don’t have data of Friday yet, but we know that they maxed repo borrowing (40,000 cr.) and have a 28 day repo of 10,000 cr. at 8.45% and an ongoing 39,000 cr. 14 day repo already borrowed.

Liquidity tightness will increase short term rates, but longer term rates continue to be low as the RBI cancelled one auction of Rs. 15,000 cr. on friday.

Right now longer term bond funds have made some money, and shorter term funds will make between 8.5% and 9.5% as short term money remains tight.

You see the big dip in the November/Early December time? That’s when the central bank had already pumped in over Rs. 60,000 cr. through the FCNR swap (net of all the other issues, forex reserves were up $10 billion, which is an addition of Rs. 60,000 cr. into the system) That money has just vanished – it provided “excess liquidity” for just one month, sadly.

If you forget everything else and look at just this data point – that nearly all additional liquidity being created is getting absorbed very fast through the banking system – you realize how inflationary it is to create more money. In the US the exact opposite is happening – the fed’s purchases of billions of dollars of assets (thus creating new money) is going right back to the Fed as “excess reserves” (which in India’s case would be a reverse repo). In India, any new money being created results in even more borrowing by banks through the repo window. The US wants inflation, that’s why it’s printing like crazy. Why are we?

The government cash balance issue is a very short term one. The RBI could have easily sorted that by letting repo be higher by that much, until the government fixed its cash balances. It could let short term interest rates rise – that is after all how money must be made expensive. The constraining of liquidity is important in the fight against inflation, though it will hurt our banks today. But Rajan is no Volcker, and we are unlikely to see our central bank even attempt to hurt current banks, even if it hurts the economy in the longer run.

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