Any mismatch in domestic liquidity (i.e. supply of RO liquidity in relation to demand) has to be corrected through effective liquidity management operations, so as to prevent offsetting capital flows, which in turn could exert pressures on the fixed peg.
The liquidity management operations of the CBO aim at ensuring the absorption of RO liquidity when the banking system remains in surplus and the injection of RO liquidity when the banking system confronts a deficit. Defined as Open Market Operations (OMO), the surplus liquidity is primarily absorbed through issuance of short-term instruments such as Central Bank’s Certificates of Deposit (CDs), issuance of debt instruments like Government Treasury Bills and Government Bonds. The Government debt instruments however, aid liquidity absorption, besides meeting the financing needs of the Government. Liquidity injection, on the other hand, is carried out through the Repurchase Agreements (Repo), using CBO’s CDs, Government Development Bonds and Government Treasury Bills, at the initiative of commercial banks with the CBO. The interest rates on CBO’s CDs and repos largely follow the trend of the US Fed Funds Target Rate, given the fixed peg, with marginal deviations in the rates reflecting the results of CD auctions and CBO’s own assessment about the liquidity conditions.
Other indirect policy instruments, such as swaps and rediscounting facility are also used occasionally in the conduct of liquidity management operations. With a view to managing structural mismatches in liquidity conditions, and also changing the overall monetary and credit conditions in the system, direct policy instruments are also used at times, primarily in the form of changing the Reserve Requirement and the Lending Ratio. Certain Prudential Regulations for banks also support the liquidity management operations of the CBO.
In the process of managing domestic liquidity, the CBO also aims at promoting a deep and active money market.