Money market witnessed higher rate transmission post 100 bps rate cut

Bonds

The transmission of policy rate cuts to money market instruments has been significantly stronger since the 100 basis points (bps) rate reduction implemented by the Reserve Bank of India (RBI) starting February this year.

The sharper decline in rates may largely be attributed to surplus liquidity in the banking system, which may have caused rates for instruments such as call money, treasury bills, commercial papers, and certificates of deposit to ease by more than 100 bps.

According to RBI data, in response to the cumulative 100 bps cut in the policy repo rate during the current easing cycle (up to August 4), the weighted average call money rate (WACR) declined by 108 bps.

Since the February policy announcement, the rate on 3-month treasury bills has dropped by 110 bps, 3-month commercial papers issued by NBFCs have fallen by 161 bps, and 3-month certificates of deposit have declined by 170 bps.

Usually, when the liquidity in the banking system is in a surplus mode, it allows banks and other institutions to lend more either to retail investors or to other institutions in the money market, which leads to fall in rates on these instruments.

Experts said that easing money market rates can help banks report a better treasury gains because as the yields on short-term instruments like treasury bills and commercial papers fall, the market value of banks’ existing holdings in these securities typically rises, leading to capital gains. Further, it can also reduce borrowing cost for the banks.

The liquidity in the banking system turned to surplus mode after RBI started infusing durable liquidity through various instruments such as open market operations (OMOs) purchases of governments securities and USD/INR buy-sell swap auctions, since start of this year.

Additionally, the liquidity also got support from the daily variable rate repo auction conducted by the RBI, normal VRR auctions, government month-end spending, and increase in government capital expenditure.

Currently, liquidity in the banking system is in surplus of around Rs 3.99 lakh crore, as per RBI’s data.

The infusion of liquidity in the banking system came under stress from November last year for numerous reasons, including tax payments related outflows, heavy selling by foreign portfolio investors in Indian equities and the consequent intervention by the RBI in the forex market to sell dollars, along with lower-than-anticipated government spending.

These measures have helped the money market rates to ease faster than expected, and make borrowing cost cheaper for the corporates and banks.

Further, the liquidity surplus is expected to widen going ahead due to release of Cash Reserve Ratio (CRR) balances, which has been cut by the RBI in June monetary policy.

The RBI CRR cut will give a boost to liquidity in the banking system. This will add Rs 2.5 lakh crore liquidity to the banking system. The CRR cut is scheduled in four tranches of 25 bps each starting from the fortnight beginning September 6, followed by October 4, November 1 and November 29, 2025.