The Reserve Bank of India (RBI) has announced bond purchase programme to inject liquidity into the banking system. Starting in May 2025, the RBI will acquire government bonds worth 1.25 trillion rupees. This action aims to facilitate smoother monetary policy transmission and ensure adequate liquidity levels.
Bond Purchase Details
The RBI’s bond purchase will occur in four tranches. The first tranche is set for May 6, amounting to 50,000 crore rupees. This will be followed by three additional tranches of 25,000 crore rupees each on May 9, May 15, and May 19. This structured approach allows the RBI to manage liquidity effectively over the month.
Previous Liquidity Measures
Recently, the RBI infused approximately 1.2 trillion rupees into the banking system through debt purchases and foreign exchange swaps. This earlier measure was part of a broader strategy to maintain market stability and support economic growth.
Repo Rate Adjustment
In conjunction with the bond purchases, the RBI has lowered the repo rate for the second consecutive time. This shift to an “accommodative” monetary policy stance aims to encourage lending and investment. The current repo rate adjustment is designed to stimulate economic activity amid fluctuating market conditions.
Banking System Surplus
The RBI aims to maintain a surplus of around 1% of total deposits in the banking system. As of the week ending April 25, the average surplus was reported at 80,900 crore rupees, a decrease from 1.78 trillion rupees the previous week. This adjustment reflects the RBI’s ongoing efforts to balance liquidity with the need for effective monetary policy implementation.
Impact on Financial Markets
The bond purchase programme is expected to influence the yield curve and overall financial market dynamics. By purchasing government bonds, the RBI aims to lower bond yields, making borrowing cheaper for businesses and consumers. This could lead to increased investment and spending in the economy.
Future Expectations
The RBI’s actions indicate a commitment to ensuring sufficient liquidity in the banking system. Governor Sanjay Malhotra has emphasised the importance of maintaining a stable financial environment. Future measures may include further adjustments to the repo rate or additional liquidity infusions, depending on economic conditions.
Conclusion
The RBI’s proactive measures in May 2025 reflect its commitment to supporting the economy through strategic liquidity management. These initiatives are crucial for encouraging growth and stability in the financial sector.
Questions for UPSC:
- Examine the role of the Reserve Bank of India in managing liquidity in the banking system.
- Discuss the implications of the repo rate changes on the Indian economy.
- How does the bond purchase programme influence the yield curve in financial markets?
- Critically discuss the relationship between monetary policy and economic growth in India.
Answer Hints:
1. Examine the role of the Reserve Bank of India in managing liquidity in the banking system.
- The RBI conducts open market operations to buy/sell government securities, influencing liquidity levels.
- It sets the repo rate, which affects borrowing costs for banks, thereby impacting overall liquidity.
- Through liquidity infusion measures, such as the recent bond purchases, the RBI ensures adequate funds in the banking system.
- The central bank monitors daily surplus levels to maintain a balance conducive for policy transmission.
- It also employs tools like cash reserve ratio (CRR) to control the amount of funds banks can lend, further managing liquidity.
2. Discuss the implications of the repo rate changes on the Indian economy.
- Lowering the repo rate reduces borrowing costs for banks, encouraging lending to businesses and consumers.
- This can stimulate economic growth by increasing investment and consumer spending.
- Changes in the repo rate can also influence inflation rates, as cheaper loans may boost demand.
- A lower rate enhances liquidity in the market, supporting financial stability and confidence among investors.
- Conversely, prolonged low rates may lead to asset bubbles if not managed carefully.
3. How does the bond purchase programme influence the yield curve in financial markets?
- The RBI’s bond purchases increase demand for government securities, leading to higher prices and lower yields.
- Lower yields on bonds reduce the cost of borrowing, which can stimulate economic activity.
- The programme helps flatten the yield curve, indicating lower long-term interest rates compared to short-term rates.
- This can encourage investors to shift towards riskier assets, impacting overall market dynamics.
- Changes in the yield curve also provide vital information about market expectations regarding future economic conditions.
4. Critically discuss the relationship between monetary policy and economic growth in India.
- Monetary policy directly influences interest rates, which affect investment and consumption levels in the economy.
- Expansionary policies, such as lowering rates, can boost economic growth by increasing liquidity and encouraging spending.
- Conversely, tight monetary policies may slow growth by increasing borrowing costs and reducing credit availability.
- The effectiveness of monetary policy is contingent upon external factors like global economic conditions and domestic inflation rates.
- Long-term growth also relies on structural reforms and fiscal policies that complement monetary measures.
