The Reserve Bank of India (RBI) has initiated discussions with major financial market players regarding the alignment of the overnight interbank call money rate closer to the policy repo rate. This follows a recent report indicating the RBI’s intention to bring these rates into closer parity through strategic measures. Currently, there is a notable disparity between the rates, with the policy repo rate at 5.50%, while the overnight call rate averages around 5.30%. Since April, both the overnight call and TREPS rates have consistently remained below the policy rate. The RBI's concern lies in ensuring that banks are not excessively reliant on cheaper funding options than intended.

RBI Engages Market Participants for Rate Alignment

In a significant move, the Reserve Bank of India convened large treasury officials last Friday to assess liquidity conditions and investigate why the overnight call rate continues to lag behind the repo rate. Discussions centered on understanding the reasons behind this persistent discrepancy. Additionally, the central bank sought insights into the recent spike in treasury bill yields, which were notably higher than expected last week.

Amidst these deliberations, the RBI appears poised to introduce variable rate reverse repo auctions as a mechanism to absorb surplus liquidity when necessary. This approach aims to stabilize short-term rates and enhance monetary policy transmission. In recent weeks, the weighted average overnight call rate has hovered near the Standing Deposit Facility rate, reflecting its proximity to the policy corridor’s lower limit.

On June 6, the RBI reduced its key policy rate by 50 basis points but shifted its stance to neutral, signaling limited potential for further cuts. Concurrently, it announced a decrease in banks’ cash reserve ratio starting September. Since June 11, the RBI ceased daily fund infusion via variable rate repo, interpreted by the market as an indication of imminent transition towards variable rate reverse repo operations.

Market participants advocate for smooth liquidity management to mitigate volatility in short-term rates. According to Gaura Sen Gupta, chief economist at IDFC First Bank, aligning overnight rates with the repo rate over time could facilitate enhanced monetary policy transmission, reinforcing the importance of managing expectations effectively.

From a journalistic perspective, this initiative underscores the RBI's commitment to refining monetary policy tools. By fostering better alignment between key rates, the central bank seeks to bolster economic stability and ensure efficient capital flow within the banking system. This development serves as a reminder of the intricate balance required in managing liquidity and interest rates in an evolving financial landscape.