RBI considering exclusive LAF auction for PDs

By Our Staff Reporter

HYDERABAD, JULY 8. The Reserve Bank of India is closely monitoring the Liquidity Adjustment Facility (LAF) introduced on June 5, and one of the suggestions being considered is holding a second auction exclusively for primary dealers (PDs) well before the close of call money market, according to Dr. Y. V. Reddy, Deputy Governor, RBI.

Delivering the key note address on ``Analysing economic policy'', at the Andhra Pradesh Press Academy here on Saturday, Dr. Reddy said it was only a month since the first phase of the LAF was introduced, and everyone was on a `learning curve'. But during the next one year, the RBI was confident of reaching the fullfledged LAF with multiple auctions, based on electronic dealing, he said.

On suggestions from the PDs, he said one option being advocated was a second auction, where PDs would once again bid for liquidity even if it were at minimum prescribed mark-up, say varying in the range of one to three per cent over the cut-off rate fixed in the first LAF auction. He welcomed responses to this suggestion and said it would help RBI to take decisions to meet temporary problems.

The RBI has held meetings with Primary Dealers Association and Fixed Income Money Market and Derivatives Association of India (FIMMDAI) to obtain their feedback. A seminar on LAF is also being proposed in August, to share experiences with reference to theory and practice.

The scheme is being implemented in phases to ensure smooth transition and keep pace with technological upgradation. In the first phase, the RBI is conducting a set of repo auctions for absorption of liquidity and reverse repo auctions for injection of liquidity in which banks and primary dealers participate. The whole process, which is a daily event, is completed with a couple of hours.

There have been a variety of reactions to the operation of the scheme, with some lending banks claiming that it was biased against them while the PDs feel that LAF has created more volatility rather then ensuring stability in the money market. They felt LAF resulted in increase in call money rates since market participants tend to bid higher in order to be assured of funds.

It was inevitable that the cut-off rates in LAF have an impact on the call money rates, since the market reads from the actions of the Reserve Bank. When the fullfledged LAF is in operation, RBI will be in a position to manage the liquidity better and influence the short-term interest rates in line with the overall monetary policy stance, he said.

The RBI would be flexible on the operating procedures and fine tune the policy as well as the pace of implementation, but the ultimate objective would be an efficient fullfledged LAF, involving multiple auction on the same day, replacing the traditional assured sources of liquidity from RBI at fixed interest rates, he said.

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