Indian Lenders Urge RBI for Liquidity Easing Amidst Prolonged Cash Rate Stress

Indian lenders are urging the Reserve Bank of India (RBI) to ease liquidity conditions within the banking system, citing concerns over overnight cash rates surpassing the key policy rate for over five months. Treasury officials plan to present these concerns to the RBI ahead of the upcoming policy meeting next month.

Banks anticipate that with a forecasted easing of inflation, the RBI will respond by relaxing liquidity constraints, possibly shifting into a surplus. The prolonged high rates are causing challenges for lenders.

Suggestions were communicated to the Fixed Income Money Market and Derivatives Association of India (FIMMDA) on Wednesday. FIMMDA officials were unavailable for immediate comment and did not respond to Reuters’ inquiries.

The RBI had tightened banking liquidity in mid-2023 to counter inflationary pressures, following a period of cash abundance due to the withdrawal of 2,000-rupee currency notes. The central bank’s rate-setting panel had raised the benchmark policy rate by 250 basis points between May 2022 and February 2023, reaching 6.50%.

Currently, India’s banking system faces a liquidity deficit of around 2 trillion rupees ($24 billion), pushing the weighted average interbank lending rate to nearly 6.75%. In response to tightening liquidity, the RBI ceased withdrawing cash through variable rate reverse repos and began intermittent auctions, like a recent three-day, 500-billion rupees variable rate repo on Friday.

Treasury officials anticipate an increase in both the amount and frequency of these repos. A senior treasury official at a state-run bank highlighted the need for the RBI to address the market’s scarcity of durable liquidity, suggesting that the 14-day Variable Rate Repo (VRR) might be the preferred liquidity infusion tool for the RBI in the coming quarter. The RBI’s rate-setting panel is set to make its next policy decision on February 8.