Turbulence in Indian Money Market – Call Rates Shoot Up
Monetary measures taken by Reserve Bank of India in the recent past in response to the huge credit growth and growing fears of inflation getting out of control, coupled with other seasonal factors like advance tax outflows, have led to a sever liquidity crunch in the Indian banking system. The cash squeeze led the call money rates to shoot up to as high as 20% this Friday.
This is much beyond the ceiling provided by the central bank’s repurchase window and something rarely since the monetary reforms began and the repurchase window was introduced as a mechanism to provide stability in the money market by providing a ‘corridor’ for overnight rates.
Bank credit has been growing at over 30% and the central bank is worried about the inflationary trends. As part of its continuing tightening policy, the RBI announced a two-phase hike in the Cash Reserve Ratio (CRR) earlier this month. CRR is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. The first phase kicked in on last Saturday (December 23) and the second phase will be effective from January 6.
Compared to an estimated surplus of about Rs 25,000-30,000 crore in the beginning of this month, there is a cash shortage of about Rs. 12-15000 crore now. The central bank injected an average of Rs. 12500 crore daily last week through its repurchase window, up from Rs. 4000 crore in the previous week. The repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities.
The reason for the rates shooting up much beyond the repo rate of 7.25% is the decline in the bank’s holding of government bonds. With most of the banks’ holding being close to the minimum SLR requirement of 25%, they are not able to borrow from RBI under the repurchase window.
How long will the cash crunch last? It is expected to ease in the coming weeks, as coupon payments, government expenditure and special deposit scheme redemptions will bring back some cash into the system. These may bring the call rates closer to the repo rate of 7.25% - the informal ‘ceiling’ provided by the repurchase window. The days of easy money are, however, over. And, the banks should be ready for occasional bouts of volatility.
Monetary measures taken by Reserve Bank of India in the recent past in response to the huge credit growth and growing fears of inflation getting out of control, coupled with other seasonal factors like advance tax outflows, have led to a sever liquidity crunch in the Indian banking system. The cash squeeze led the call money rates to shoot up to as high as 20% this Friday.
This is much beyond the ceiling provided by the central bank’s repurchase window and something rarely since the monetary reforms began and the repurchase window was introduced as a mechanism to provide stability in the money market by providing a ‘corridor’ for overnight rates.
Bank credit has been growing at over 30% and the central bank is worried about the inflationary trends. As part of its continuing tightening policy, the RBI announced a two-phase hike in the Cash Reserve Ratio (CRR) earlier this month. CRR is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. The first phase kicked in on last Saturday (December 23) and the second phase will be effective from January 6.
Compared to an estimated surplus of about Rs 25,000-30,000 crore in the beginning of this month, there is a cash shortage of about Rs. 12-15000 crore now. The central bank injected an average of Rs. 12500 crore daily last week through its repurchase window, up from Rs. 4000 crore in the previous week. The repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities.
The reason for the rates shooting up much beyond the repo rate of 7.25% is the decline in the bank’s holding of government bonds. With most of the banks’ holding being close to the minimum SLR requirement of 25%, they are not able to borrow from RBI under the repurchase window.
How long will the cash crunch last? It is expected to ease in the coming weeks, as coupon payments, government expenditure and special deposit scheme redemptions will bring back some cash into the system. These may bring the call rates closer to the repo rate of 7.25% - the informal ‘ceiling’ provided by the repurchase window. The days of easy money are, however, over. And, the banks should be ready for occasional bouts of volatility.
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