Business Business: Since the beginning of the interest rate cut cycle, the Reserve Bank of India (RBI) has been focusing more on the overnight rate or call money rate as it is a key measure of liquidity in the banking system and an important channel for the transmission of interest rates.
The focus on the overnight rate has increased after the gap between the call money rate and the repo rate increased. And this increased attention stems from the fact that a high gap between these rates can fuel inflation.
While there are no concerns on the inflation front right now, current geopolitical tensions and cheap funds could impact the pace of price growth, forcing the central bank to re-evaluate its projections.
More on this topic here.
When did the RBI start paying more attention to the overnight rate?
The RBI has been monitoring the overnight rate as a central operating target for monetary policy implementation since the beginning of 2025.
This increased focus comes following the recommendations of an internal working group headed by RBI deputy governor Poonam Gupta, which reviewed the existing liquidity management framework.
The panel observed that the weighted average call rate, or WACR, is highly effective in reflecting liquidity conditions and transmitting policy signals across various money market instruments.
Does it help in liquidity management?
Money market experts say that the call rate, or overnight rate, plays a key role in effective liquidity management for the RBI.
This is because aligning the call money rate with the repo rate helps the RBI to efficiently manage surplus or deficit liquidity. This not only ensures smooth transmission of monetary policy but also stabilizes short-term interest rates in the money market, thereby enhancing overall financial stability and operational efficiency.
Will it impact interest rates on loans?
Bringing the overnight rate closer to the repo rate ensures effective transmission of monetary policy to other segments of the money market, such as treasury bills, commercial paper and inter-bank borrowings. As these short-term rates rise or fall in line with the overnight rate, banks experience a change in their cost of funds.
Typically, lower borrowing costs in the money market for banks enable them to provide loans at more attractive rates. Therefore, by balancing the overnight interest rates with the repo rate, the RBI can indirectly influence lending rates in the economy.
How has money market rates changed after RBI cut interest rates?
According to RBI data, the total reduction in the policy repo rate by 100 basis points (bps) during the current easing cycle (till August 4) has resulted in a decline in the WACR by 108 basis points.
Since the February policy announcement, interest rates have fallen by 110 basis points on three-month Treasury bills, by 161 basis points on three-month commercial papers issued by non-banking financial companies, and by 170 basis points on three-month certificates of deposits.
