In response to sustained pressures on the overnight cash rates exceeding the key policy rate for over five months, Indian lenders are advocating for the Reserve Bank of India (RBI) to ease liquidity conditions within the banking system. Treasury officials, representing the banks, intend to share their recommendations with the RBI ahead of the upcoming policy meeting next month.
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With inflation expected to abate in the coming months, banks are optimistic that the central bank will take measures to loosen liquidity, potentially moving it into surplus. The elevated cash rates have posed challenges for financial institutions, prompting them to seek relief through liquidity adjustments.
Suggestions for easing liquidity conditions were presented by the banks to the Fixed Income Money Market and Derivatives Association of India (FIMMDA) on Wednesday. However, officials from FIMMDA were not immediately available for comment, and Reuters’ queries went unanswered.
The RBI had tightened banking liquidity from the middle of 2023 to counter inflationary pressures, particularly after banks were flush with cash due to the withdrawal of 2,000-rupee currency notes. The central bank’s rate-setting panel had already raised the benchmark policy rate by 250 basis points between May 2022 and February 2023 to 6.50%, unwinding the pandemic-era stimulus and aiming to curb inflation.
Currently, India’s banking system faces a liquidity deficit of around 2 trillion rupees ($24 billion), leading to a weighted average interbank lending rate near 6.75%. As liquidity tightened, the RBI ceased withdrawing cash from the banking system through variable rate reverse repos.
To address the liquidity shortage, the RBI has resorted to lending cash to banks via intermittent auctions, such as a three-day, 500-billion-rupees variable rate repo conducted on Friday. Treasury officials anticipate that the quantum and frequency of these repos will be increased in the coming months.
A senior treasury official at a state-run bank emphasized the need for regular variable rate repos, stating, “There is a dearth of durable liquidity in the market, and the RBI will have to address that by conducting variable rate repos regularly. We think that the 14-day VRR will be the preferred liquidity infusion tool for the RBI in this quarter.”
As the RBI’s rate-setting panel convenes for its next policy decision on February 8, market participants and financial institutions await the central bank’s response to the plea for looser liquidity conditions. The outcome of these deliberations will likely have significant implications for India’s financial landscape, influencing market dynamics and banking operations in the months to come.