Short-term interest rates collapse in India

A glut of cash chasing assets in India has caused short-term rates to plunge. A three-month Treasury bill was sold at a record low yield Wednesday, while the market repo clocked a trade at 0.01 per cent. Key borrowing costs like the weighted interbank call rate and collateralized money-market rates are way below the Reserve Bank of India's benchmark in recent days, indicating investors such as mutual funds are accepting returns lower than what RBI's deposit window would offer banks.

Governor Shaktikanta Das has pledged to stay accommodative well into 2021 as he tries to dig the economy out of an unprecedented technical recession. But liquidity bloat is coming from the central bank's intervention in the foreign currency market, as it seeks to rein in the rupee and keep exports competitive.

"The RBI's dollar buying to prevent the rupee from appreciating has driven liquidity to a large excess," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. "The RBI may have to act to suck out liquidity to maintain the sanctity of the reverse repo rate."

Deposit window

Banks have parked 6.1 trillion rupees ($82.5 billion) of excess cash with the central bank at the reverse repo rate of 3.35 per cent, according to the Bloomberg Banking Liquidity Index. Mutual funds and other such investors don't have access to this window, and ICICI Securities Primary Dealership suggests the RBI should consider including them if it's worried about the depression of overnight yields.

"A weekly or fortnightly liquidity absorption window with wider participation could address the skew in excess liquidity and reinforce the reverse repo rate as the floor," ICICI Securities economists including A. Prasanna wrote in a note. "A stronger option would be to introduce the Standing Deposit Facility at a rate slightly above reverse repo - say 3.5 per cent - so that money market rates reset."

The so-called SDF is a tool that would enable the central bank to take in money without offering collateral. The State Bank of India, the nation's largest lender, warned that a sustained cash surplus may eventually push loan rates below similar-rated bonds, introducing policy unpredictability. "Such type of irrational pricing, because of abundant liquidity, can impact banking sector profits and initiate asset liability mismatch, if the spread is more prevalent for lower-rated borrowers," according to Soumya Kanti Ghosh, group chief economic adviser at the lender.

Subhadip Sircar