The Hindu Business Line : What’s keeping call money rates low?

Reasons cited
RBI cap of Rs 3,000 cr through reverse repo prevents market to lend beyond this amount.
Government spending of Rs 80,000 crore over the past quarter found itself into the system.
Surplus created by RBI by not resorting to complete mopping up of rupee whenever it buys dollar,

N.S. Vageesh

Chennai, July 19 Call money rates, or the rates that banks pay for borrowing from each other overnight, have been at less than 0.5 per cent for a couple of weeks now. Banks use this avenue to borrow to meet temporary shortages of funds or to meet reserve requirements imposed by the Reserve Bank of India.

Call rates used to be in the 5.5-7 per cent range during most of the last fiscal. On rare occasions, when demand for funds was particularly high, they have climbed to over 60 per cent.

But generally call rates were supposed to be operating in a corridor between the informal floor of reverse repo rate of the RBI and ceiling of the repo rate of the RBI.

The reverse repo rate (currently at 6 per cent) of the RBI is used to borrow from the system (suck out liquidity) while the repo rate (currently at 7.75 per cent), is the rate at which the central bank lends to the system (infuses liquidity).

Now call rates have plummeted to new lows, considerably below the informal floor rate. What is behind this roller coaster ride?

It’s simply a case of too much money sloshing around in the system without an appropriate outlet. A combination of factors contributed to this.

Firstly, the RBI has put a cap of Rs 3,000 crore on its borrowing from the system through reverse repo auctions.

Mr Neeraj Gambhir, Senior General Manager, ICICI Bank, says that call rates dip now, in the absence of a floor rate.

He says, “There is no avenue for the market to lend beyond this amount. As long as liquidity is above Rs 3,000 crore, there will be a tendency for rates to fall below 6 per cent (reverse repo rate) and stay lower depending on the excess liquidity.”

Secondly, he points out, the government has been spending a considerable amount, at least Rs 80,000 crore over the past quarter, that has found itself into the system.

Thirdly, according to Mr Abheek Barua, Chief Economist, HDFC Bank, the RBI has not resorted to complete sterilisation or mopping up all the rupee that it releases into the system, whenever it buys dollar. That surplus has impacted call rates.

Fourthly, according to Mr Krishnan Sitaraman, Head-Fund Services & Fixed Income Research, Crisil, the period has coincided with a relatively sluggish loan growth during this quarter, traditionally a slow one for banks.

What is the implication of this?

For one, interest rates across the board are likely to be soft. More particularly, short term rates, which are already down considerably.

Mr Gambhir points out that Certificate of Deposit (CD) rates, which were at 10.75 per cent in March, have fallen to about 7 per cent now. Even the 10-year government security paper has seen yields drop to 7.85 per cent from 8.45 per cent in this period.

A second consequence, according to Mr Barua, is that there could be a revival of retail lending by banks that may be tempted to use the low cost resources available now.

He does not foresee the same happening on the corporate lending side, since there are alternatives such as external commercial borrowings. “The easier target would be retail loans,” he said.

He expects some corrective action from the RBI since the liquidity situation seems to be spinning out of control. That, he says, could come in the form of a hike in the Cash Reserve Ratio, currently at 6.5 per cent, the amount that banks have to park with the RBI.

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What’s keeping call money rates low?