Central Bank of India withdraws approximately $10 billion to boost short-term interest rates
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India's central bank, the Reserve Bank of India (RBI), drained 849.75 billion rupees ($10 billion) of excess cash from the banking system this month, marking its first such operation in seven months. This move was designed to lift overnight borrowing costs and better align them with its policy rate, which currently stands at 5.5%.
On July 23, the RBI withdrew funds by conducting a 7-day variable rate reverse repo auction at a 5.49% cutoff yield. The initial plan was to absorb one trillion rupees, but the final amount pulled was slightly less.
The RBI's motivation for liquidity absorption likely stems from the fact that overnight rates have been lingering below the policy rate for several months despite the RBI's generous liquidity infusions totaling over 9.5 trillion rupees since January. As of June 26, the liquidity surplus in the banking system stood at approximately 2.5 trillion rupees, according to Bloomberg Economics' Liquidity Index.
Economist Ritesh Bhusari from South Indian Bank explains that "liquidity will still be in surplus even after this operation... The RBI will keep liquidity in surplus of around 1.5%-2% of net deposits, and if it goes beyond that, they may follow up with further operations."
The move to absorb excess liquidity seems to be paying off, as overnight rates have edged higher following the central bank's announcement on Tuesday. The 7.02% 2027 bond was trading one basis point higher at 5.80%, while the benchmark 10-year bond yield rose by a similar margin to 6.29%.
In short, the RBI's decision to withdraw surplus funds was a calculated move to prevent excess liquidity from pushing down bond yields and distorting interest rate transmission, ultimately aiming to enhance the effectiveness of its monetary policy signals. By raising overnight borrowing costs closer to the policy rate, the RBI aims to maintain a balanced and healthier financial market environment, ensuring better transmission of monetary policy. So there you have it – the nitty-gritty details of the RBI's latest liquidity management operation!
- The Reserve Bank of India (RBI) recently absored excess cash from the banking system in an effort to lift overnight borrowing costs, aligning them with its policy rate.
- This move was part of the RBI's monetary policy strategy, aiming to maintain a balanced and healthier financial market environment, ensuring better transmission of monetary policy signals.
