The Reserve Bank of India aims for market rates to be aligned with the repo rate, but over the past four years, amidst extraordinary economic events, market rates have largely been disconnected from the policy rate, as liquidity conditions have been either tailored to rev up growth or battle inflation.
In the 45 months from March 2020 to November 2023, there has been only one instance of the weighted average call rate (WACR) being contained within a 10-basis-point gap with the policy repo rate, monthly bulletin data from the RBI showed.
“The operating framework of monetary policy aims at aligning the operating target – the weighted average call rate – with the policy repo rate through proactive liquidity management to facilitate transmission of repo rate changes through the entire financial system,” said the RBI’s Monetary Policy Framework.
The WACR indicates the overnight cost of borrowing for banks amongst themselves in the interbank call money market. A rise or fall in the WACR is accordingly passed on by banks in various other lending and borrowing products across the economy.
Liquidity conditions also influence the pricing of government treasury bills, which are one of the instruments used by banks as external loan benchmarks.
Two Phases of Divergence
The key factor behind the sharp disconnect between the WACR and the repo rate has been the evolution of liquidity conditions in the banking system.
Since April 2022, the RBI has been withdrawing monetary accommodation, with the central bank conducting a cumulative 250 bps of rate hikes from May 2022 to February 2023. Barring five months, the WACR has been at least 10 bps higher than the repo rate during this phase. From August to November 2023, the market rate has consistently been at least 25 bps higher than the repo rate.
Analysts said that accounting for exogenous factors like the ebbs and flows of government spending, the RBI tolerated market rates being much higher than the repo rate as a way of signalling its vigilance on inflation. Higher market rates also provide a protective buffer for the rupee in a volatile global environment.
During 2020-21, when the Covid-19 crisis engulfed India, the RBI had injected large amounts of liquidity into the banking system.
