Mumbai: The answer to the Reserve Bank of India’s (RBI) question why its rate actions are not completely transmitted through the economy may lie in the shrinking trade volumes in the very segment the central bank targets through its monetary policy – the overnight call money market.
The value of trades in the interbank call money market, which helps lubricate the financial system and is the operating target of the RBI’s monetary policy, has shrunk nearly 40% in the past four years, official data showed. Meanwhile, trades in the two other money market segments – market repos and tri-party repos – have trebled, posing a tricky question for the RBI about its rate-action impact on the economy.
“The growing importance of these markets is a potential source of dissonance for monetary policy operations, which targets the weighted average call rate (WACR) as the operating rate: It is the anchor for short-term money market instruments,” said Saugata Bhattacharya, executive vice president, Axis Bank. “If these rates diverge for sustained periods from the WACR, particularly in a skewed distribution as presently evident, this might impede efficient transmission of monetary policy signals.”
Transmission Channels
When the RBI increases or decreases interest rates to either curb inflation or spur economic growth, it expects the changes in policy rates to be effectively transmitted from the overnight call money market to the broader economy. Banks borrow and lend funds from each other in the call market.Data released by the Clearing Corporation of India showed that the value of trades in the uncollateralised call, notice and term money markets has declined 37.4% from ₹50.02 lakh crore in 2018-19 to ₹31.3 lakh crore in 2022-23. The trend of declining volumes has continued in the current financial year, with the value of trades until September 11% lower than the previous year.
Meanwhile, the value of trades in market repos and tri-party repos, which are collateralised, have surged 150% and 188%, respectively, over the same time, with the latter seeing transactions worth ₹941 lakh crore last year.
“As the volumes diverge further, pricing of instruments such as Treasury Bills will become more and more linked with the other money market segments and that has an implication for broader fund-raising instruments like certificates of deposit (CD) and commercial papers (CP) as well,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership.
CDs are instruments used by banks to raise short-term funds, while CPs are securities issued by corporates to garner money. Pricing of these is linked to the government’s T-bills.
Pooled Funds
The reasons behind the fall in call market volumes and the increased preference for the collateralised segments include a sharp increase in the flow of funds toward mutual funds and insurance companies following the 2016 demonetisation exercise and the COVID crisis four years later.
Mutual funds, which are not permitted access to the window that banks use to lend to the RBI, are huge players in the tri-party repo market, while insurance firms also opt for collateralised lending and borrowing.
“The natural lenders, which are mutual funds and insurance companies, are mostly done with their transactions by 2 pm and they typically use the CROMs (interbank repos) and the Tri-party repos to park their surplus funds,” Mihir Vora, chief investment officer, Trust Mutual Fund said.
According to the Association of Mutual Funds in India, the assets under management of mutual funds have grown from ₹22 lakh crore in September 2018 to ₹47 lakh crore in September 2023.
