Rates on short-term debt instruments are predicted to climb by an additional 5-10 basis points in the coming days following the decision by the Reserve Bank of India (RBI) to introduce an incremental cash reserve ratio (CRR) for banks. The move aims to address the surplus liquidity present in the system.
This extra CRR will be applied to the net demand and time liabilities increase of banks between May 19 and July 28. This period saw a rise of about Rs 8 lakh crore in net demand and time liabilities, translating to an estimated additional cash reserve requirement of approximately Rs 1.15 lakh crore.
Huge liquidity
The RBI’s withdrawal of 2,000-rupee banknotes, coupled with the transfer of surplus by the RBI to the government, an uptick in government spending, and capital inflows, collectively contributed to a surge in surplus liquidity in the system. Since the central bank’s announcement to withdraw 2,000-rupee notes in May, approximately Rs 3.14 lakh crore, which accounts for 88% of the outstanding notes, have been returned to the banks.
The incremental CRR is slated for review by September 8 or earlier, with the objective of releasing the impounded funds back into the system prior to the festive season. The differing impacts of this liquidity increase, particularly favouring public sector banks, have drawn attention to the potential for inequality among banking institutions.
Rates rise
As a result of the RBI’s action, short-term paper rates experienced an 8-10 basis point rise. Rates for three-month commercial papers issued by non-banking financial companies as well as papers from manufacturing companies and certificates of deposit all recorded increases.
Despite short-term market turbulence, experts believe that the situation will normalise. Current estimates suggest a banking system liquidity surplus of Rs 2.64 lakh crore, as compared to the previous Rs 2.11 lakh crore. Market participants are hopeful that the RBI will retract the incremental CRR by September 8 to ensure sufficient liquidity in the banking system.
While this move might briefly impact money market yields, experts anticipate minimal effects on the bond yield curve. However, the reduction in liquidity surplus is expected to endure due to routine outflows linked to tax payments and the impending festival season. This scenario is likely to sustain higher rates on short-term debt instruments, thereby elevating borrowing costs.
In response to the RBI’s actions, banks may adopt a more cautious approach, focusing on mobilising funds through deposits and potentially increasing the issuance of certificates of deposit. The impact on commercial paper issuances is projected to be transient as issuers may choose to await market stability before seeking to refinance their existing debt in the short-term debt market.
