Overnight money rates in India’s money markets have moved up sharply in the last couple of days owing to a cash shortage generated due to (advance) tax outflows. Tax outflows are estimated to have sucked out approximately Rs. 400 bn from the banking system.
A visual display of the movement in call money (clean uncollaterlatized lending / borrowing) rates for the past few months is shown below.
(Click on the thumbnail to get a better picture)
The extent of the tightness in the markets (showing up in the sharp spurt in rates) comes as some sort of a surprise since tax outflows are generally known and factored in by bankers. Coming as it does after a spell of easy money (induced partly by RBI’s revised liquidity management measures), it seems to have taken some market participants by surprise.
This is also visible in the activity in the forex markets with the local currency (INR) appreciating, in intra day trading, against the US dollar. INR which opened at 44.10 to the dollar is currently trading at 43.95 (0630 hrs GMT). Bankers seem to be selling dollars to meet the cash needs.
While tax outflow would find their way back into the system as government spending picks up, (I expect money rates to ease off in the next couple of days) it remains to be seen if the forex markets feel the impact then, too.
One of the monetary policy objectives is to keep the overnight money rates within the corridor of the repo rate and reverse repo rate, which stand at 7.50% and 6% respectively today. However, some of the policy measures taken of late, seem to have created conditions that are ripe for the rates to actually move out of the corridor (both below the floor of 6% as well as the cap of 7.5%).
While technically, rates moving above the repo rate (the envisaged cap) is due the the shortage of delivarable securities in banks’ portfolios, it should still be a matter of concern for policymakers.
It remains to be seen how the central bank handles this. Maybe they don’t really care, since at least for the time being it suits them. But then, isn’t policymaking supposed to look forward into the medium and the long term too.
Update : INR has closed today’s trading session at 44.73 to the US Dollar, a level not seen since September 2005. Clearly, the cash shortage is significant. It also appears that the RBI which normally intervenes aggressively when the local currency moves sharply seems to have let it go (at least for today). Money rates could once again open firm in tomorrow’s trading session.