The yield on short-term debt instruments such as commercial papers (CP) and certificates of deposit (CDs) have fallen by 10-15 basis points (bps) in the last two days after a sharp drop in the liquidity deficit in the banking system.
“Improved liquidity on account of government spending and tax refunds drove the overnight rates down near the repo rate and short-term CD, CP rates fell by 10-15 bps,” said V. Ramachandra Reddy, head, treasury, Karur Vysya Bank.
The tight liquidity conditions in the system eased significantly in the last few days and turned surplus on March 4. This was on the back of month-end government spending on account of salaries and pensions and likely intervention by the Reserve Bank of India (RBI) in the forex market, Kotak Mahindra Bank said in a report dated March 4.
The liquidity deficit, which was Rs 2.42 lakh crore on February 26, reversing to a surplus of Rs 40,901.86 crore on March 4.
Reacting to this, the weightage average call money rate—the interest paid by banks to borrow from and lend to each other for the short term—saw a sharp drop to 6.4853 percent on March 5. Similarly, yield on CDs maturing in three months fell to 7.75 percent on March 4, compared to 7.81 percent on March 1.
“Short-term yields respond immediately to the prevailing liquidity condition. Hence, short-term rates came down due to the RBI's active intervention through VRR (variable rate repo) auctions in a series but with a precautionary approach,” said Mataprasad Pandey, vice president, Arete Capital Service.
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RBI’s fine-tuning operation
In the last few days, the central bank started conducting variable rate reverse repo (VRRR) auctions despite the liquidity in the banking system remained in deficit. This experts said is because a few banks had surplus liquidity, which they were parking in Standing Deposit Facility (SDF).
Also, because of surplus liquidity with few banks and sharp drop in liquidity, call money rate were trading below repo rate. So, to align it near repo, RBI conducts VRRR auctions, experts added.
Since February 28, the central bank has conducted seven VRRR auctions to remove excess surplus liquidity. During this period, few banks having surplus funds started parking funds in standing deposit facility (SDF).
On February 28, banks parked Rs 66,059 crore, Rs 63,351 crore the next day, Rs 76,402 crore on March 1 and Rs 1.19 lakh crore on March 4.
This has also resulted in the overnight weighted average call money rate hovering below the repo rate. Pandey from Arete Capital Services said the RBI will keep announcing VRRR auction whenever the SDF volume goes beyond its comfort zone as the central bank finds it inflationary in nature.
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Liquidity outlook
Money market experts expect liquidity in the banking system to further ease due to expected inflows from government spending, coupons and redemption of treasury bills and state development loans.
However, they added that adjustments through VRRR auctions by the RBI should keep the overnight rate closer to the repo rate.
“This week, we expect liquidity conditions to ease closer towards the neutral zone with the continued government spending more than offsetting excise duty collections and CIC (Currency in Circulation) leakage,” Upasna Bhardwaj, chief economist, Kotak Mahindra Bank, said in a report.
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