Ask NiyaIn a quantity-based monetary targeting framework, the Reserve Money (RM) was used as the operating target, and bank reserves were the operating instrument.
The intermediate target in this framework was broad money (M3), which was closely monitored to align monetary growth with macroeconomic goals.
Over time, the RBI reduced reliance on direct instruments of monetary policy and shifted towards indirect methods focused on liquidity management.
Liquidity in the system began to be managed primarily through Open Market Operations (OMO), including outright purchase/sale of government securities and repo/reverse repo transactions under the Liquidity Adjustment Facility (LAF).
Introduced in June 2000, the LAF has emerged as the primary tool for managing short-term liquidity and stabilizing the overnight (call) money market.
The LAF operates through daily repo and reverse repo auctions, effectively setting an interest rate corridor aligned with policy objectives.
Though there is no formal targeting of overnight interest rates, LAF operations have enabled the RBI to shift focus from targeting bank reserves to managing interest rates.
This shift has also supported a gradual reduction in the Cash Reserve Ratio (CRR) without creating liquidity pressures.
Based on the recommendations of an RBI Internal Group, the LAF scheme was revised on March 25, 2004.
Under the revised scheme, the RBI retained discretion to conduct overnight reverse repo or longer-term reverse repo auctions at either fixed or variable rates, depending on market conditions and relevant factors.
The RBI also retained the ability to change the spread between the repo and reverse repo rate whenever deemed appropriate.
Ask Niya