Short-term borrowing rates have hit uncomfortably high levels days after the Reserve Bank of India’s assurances to manage liquidity in the banking system.
The weighted average call money rate, a crucial indicator for the RBI’s monetary policy, had briefly eased towards the repo rate of 6.50% last week, breaking away from the higher marginal standing facility rate where it had lingered for the past five months. This shift occurred just ahead of the monetary policy review on February 8, during which top RBI officials pledged to maintain the overnight rate close to the repo rate. Despite the central bank’s interventions, the call money rate experienced a resurgence.
Short-term borrowing instruments, such as certificates of deposit used by banks, have seen the three-month CD rates rise by 382 basis points since April 2022 to 7.83-8.03%.
Non-banking finance companies face even more challenging conditions, with rates on three-month commercial paper issued by non-banks surging by 430 basis points since April 2022 to 8.60-8.80%, inclusive of the impact of new risk weight norms imposed by the RBI.
Market analysts anticipate that system liquidity will remain tight and highly volatile for the remainder of the fiscal year, impacting mutual funds’ demand and issuers’ borrowing costs.
Despite a brief moderation of call money rates last week due to government spending, short-term debt rates have not shown any relief, and market participants do not anticipate a decrease in elevated rates. There are concerns that rates may increase by another 10-20 basis points in the coming weeks if liquidity conditions do not see sustained improvement.
The RBI steps
Post-policy, the RBI engaged in variable rate repos of 14-day and three-day maturities and injected Rs 50000 crore through two equal four-day operations. However, overnight rates remained tied to the Marginal Standing Facility (MSF) rate, with the liquidity deficit in the banking system climbing to Rs 2.05 lakh crore on Tuesday from Rs 1.10 lakh crore on February 4.
Several factors contribute to the persistent tight liquidity, including outflows from the banking system due to excise duty payments, weekly bond auction payments, and a lack of government spending observed in early February. Since mid-December, liquidity has consistently been in deficit, exceeding Rs 1 lakh crore, primarily due to subdued government expenditure and significant tax outflows from the banking system.
Despite the Monetary Policy Committee’s decision last week to refrain from softening its ‘withdrawal of accommodation’ stance, certain segments of the debt market have tightened more than the policy rate itself. This tightening is attributed to tight liquidity conditions and robust economic activity.
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