India funding costs surge to one-month high on cash squeeze

Overnight funding costs in India have surged above the central bank’s policy rate, a sign that the excess cash in the banking system has dried up.

The weighted average call rate, an overnight funding cost rate that the central bank monitors, have climbed almost 30 basis points since the start of the year. At 6.78% on Wednesday, it’s just hovering above the upper band of the Reserve Bank of India’s interest-rate corridor of 6.75%.

The excess cash that banks park with the RBI has dwindled to 788 billion rupees ($9.6 billion), from as high as 9 trillion rupees in 2022, as the central bank delivered a series of rate hikes to tackle inflation. For money managers, the tightness makes shorter papers like treasury bills and liquid funds more attractive.
The higher overnight rate is almost equivalent to a rate hike, even though the RBI paused in the April policy, according to Kaushik Das, chief India economist at Deutsche Bank AG. That may mean there is no justification for more hikes with the April inflation print also likely to sharply ease, Das said.

Bandhan Asset Management Ltd. says treasury bill rates have risen to attractive levels while Quantum Asset Management Ltd. is advising shorter-term investors to buy liquid funds.

However, the liquidity crunch may ease soon as the central bank’s dollar purchases in the forex market is adding cash and its dividend payment to the government is due.

“The current liquidity tightness phase is being driven by diminishing core liquidity unlike previous recent episodes which were more owing to higher government cash balances,” said Suyash Choudhary, head of fixed income at Bandhan Asset Management. “Thus this requires more permanent solutions and cannot be termed as ‘frictional.”