India's central bank is expected to permit overnight interbank funding costs to remain close to the lower edge of its policy corridor for a longer period, choosing not to withdraw liquidity immediately in order to avoid destabilising government bond markets, bankers said.
Lower overnight rates have provided some breathing room for a market coping with the fallout from the Iran war that has pushed oil prices higher and increased volatility in the rupee. The weighted average call money rate (WACR) has traded below 5.10% so far in April and is projected to fall further as liquidity in the banking system moves into an ample surplus.
Data points to a pronounced liquidity cushion: the secured overnight borrowing rate has fallen to about 4.80%, underscoring the extent of excess cash available to banks. For most of February and March, the WACR hovered around 5.10%, and market participants had anticipated that the central bank would initiate liquidity-draining operations at the start of the new fiscal year in April to nudge the WACR back toward the 5.25% policy rate.
In February, the central bank stated that it aims to keep the WACR at or close to its policy rate. But some market participants argue that forcing liquidity out now could do more harm than good to sentiment in an already fragile debt market.
"Since the RBI tolerated it for the last two months, there is no point in disturbing the markets at a time when a small negative point could trigger a larger selloff in government bonds," said the head of treasury at a large private bank, speaking on condition of anonymity because he was not authorised to speak to media.
Karur Vysya Bank's treasury head, VRC Reddy, said tightening moves such as variable rate reverse repos appear unnecessary at this stage. "There is little risk in allowing overnight rates to remain near the lower bound of the policy corridor for some more time," he said, adding that he expects the central bank to maintain a neutral tone at its upcoming policy decision due on Wednesday, "without signalling any significant concern."
Liquidity surplus in the system stood at roughly 4 trillion rupees, and with about 1.2 trillion rupees scheduled to flow in from maturing government securities this week, the surplus could reach roughly 2% of deposits - comfortably above the 1% threshold the central bank flagged in December.
Axis Bank's Tanay Dalal, senior vice president for business and economic research, noted that while conventional monetary tightening remains a valid tool for defending the currency, authorities are likely to rely on regulatory and unconventional instruments instead of immediate rate-based liquidity withdrawal.
($1 = 92.96 Indian rupees)