Explained: What is SDF, the RBI’s new tool to absorb excess liquidity to control inflation?

What is the News?

The Reserve Bank of India(RBI) has introduced the Standing Deposit Facility(SDF), an additional tool for absorbing liquidity, at an interest rate of 3.75%.

What is a Standing Deposit Facility(SDF)?

Introduced in: 2018 by Reserve Bank of India by amending Section 17 of the RBI Act.

Purpose: It is an additional tool for absorbing liquidity without any collateral.By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. 

Committee: The SDF was suggested in 2014 by a committee headed by Urjit Patel.

Why was SDF introduced now?

The extraordinary liquidity measures undertaken in the wake of the pandemic combined with the liquidity injected through various other operations of the RBI have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system.This has pushed up the retail inflation level in the system.

Hence, that’s why SDF has been introduced.It will help reduce the excess liquidity in the system and also control inflation.

How will the SDF facility operate?

The SDF would replace the Fixed Rate Reverse Repo(FRRR) as the floor of the Liquidity Adjustment Facility(LAF) corridor.

At present, SDF rate will be 25 basis points (bps) below the policy repo rate.Eligible participants can place deposits with the RBI on an overnight basis at the fixed rate.However, the RBI retains the flexibility to absorb liquidity for longer tenors under the SDF with appropriate pricing, as and when the need arises.

What will happen to the Reserve Repo Rate then?

The fixed rate reverse repo (FRRR) rate will remain part of the RBI’s toolkit and its operation will be at the discretion of the RBI for purposes specified from time to time. 

This means that FRRR along with the SDF will impart flexibility to the RBI’s liquidity management framework.

Source: This post is based on the article “Explained: What is SDF, the RBI’s new tool to absorb excess liquidity to control inflation?” published in Indian Express on 8th April 2022.