Short-term rates likely to fall

The Reserve Bank's 75 basis points cut in cash reserve ratio will help in margin improvement for banks. The short-term rates, which have spiked sharply in the last fortnight, are likely to decline, which in turn will ease cost of funds.

The reserves parked with the RBI does not yield any returns. The freed reserves due to the reserve ratio cut can be invested in assets which would earn returns for banks improving their net interest margin.

RBI had purchased government bonds worth Rs 52,000 crore from the secondary market to ease liquidity since the earlier cut in January. But, lack of deposits inflows and high government borrowing had continued to weigh on liquidity. The auction of government securities alone sucked out Rs 74,000 crore from the system during this time. With higher State government borrowing, the impact could have been far adverse. Together these neutered the central bank's liquidity easing moves.

Liquidity deficit forced banks to borrow short-term certificate of deposits at rates upwards of 11 per cent — highest since November 2008. These rates are higher than the base rates of most banks. Another reason for high short-term rates is the restriction of investments by banks in liquid funds which purchase these deposits.

With government's borrowing window now closed, the demand for liquidity will only come from advance tax outflows and any intervention by the RBI in the forex market.

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