RBI address liquidity shortfall

A day after holding the benchmark rates steady, the central bank stepped in to address the on-going liquidity shortfall. At its policy review, the Reserve Bank of India acknowledged the liquidity crunch in Oct-Nov on slower government spending and festive seasonal effects. These led to a shift in the liquidity stance, from net absorption to injection in the past two months, to an average INR 372bn in Oct and up to INR 856bn in Nov. 

Further, institutions briefly tapped the emergency window earlier this week, which faces a higher penalty rate. Conditions are likely to remain in deficit mode over the next couple of months as the government focuses on meeting deficit targets and advance tax outflows aggravate the strain. 

Reflecting this crunch, short-term rates have hovered above the policy rates last month, threatening to dilute the impact of the accommodative policy stance and further slow the transmission mechanism. Banks have been slow to pass on changes in the policy rates, while money markets had eased by a bigger margin. Long-term yields have also rebounded from lows seen in wake of the bunchedup rate cut in Sep, with firmer US rates also providing a floor to the Indian rates. 

The RBI plans to infuse INR 100bn early next week through open market operations, with more injections through the repo window also expected over the course of the next few weeks. More permanent injection of liquidity through reserve ratio cuts are however unlikely.