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Thu 14 Mar 2019 09:44 AM

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India's Central Bank injects liquidity into mark in bid to soften lending rates

The Reserve Bank of India is slated to buy back $1.8 billion worth of government securities this week

India's Central Bank injects liquidity into mark in bid to soften lending rates

India’s central bank, RBI has begun pumping additional liquidity into the market through open market operations (OMOs) apparently aimed at softening lending rates and possibly push up private consumption to spur sagging economic growth.

In its latest open market operation, RBI is slated to buy back about $1.8 billion worth government securities later this week.

The central bank’s move, however, surprised many in the corporate and financial sector and economists, who said there was no liquidity issue in the market nor any significant pick-up in credit take-off to warrant such a move. 

“Though there was no apparent liquidity issue in the market, the RBI decision to pump in money (through open market operations) into the market could be aimed at softening the interest rates,” Krishnamurthy Vijayan, CEO of Tamil Nadu Infrastructure Fund Management, told Arabian Business.

Despite the central bank reducing its repo rate by 25 basis points to 6.25 percent at its last monetary policy review meeting in February, it has failed to result in a matching reduction in interest rates. 

Market analysts said this was mainly because of a mismatch in deposit and lending rates by banks.

A surge in liquidity in the system may, however, force banks to soften the lending rates, they said.

RBI’s decision to pump in additional liquidity has already resulted in sliding of interest rates in India’s liquid fund market to 3-4 percent from the earlier 7 percent.

“Companies with surplus funds are reluctant to deploy these funds in the liquid fund market due to the sharp slide in returns. These companies will now have to look at alternate options to use their surplus funds as they cannot sit on it,” R. Guha, finance director at Akzo Nobel India, told Arabian Business.

There are possibilities that the companies which are sitting on surplus funds could be going in for either paying additional dividends or even buy back of shares which could increase their share valuations, he said.

“The objective of the RBI move (OMOs) will be to address the anticipated liquidity tightness and softening interest rates, paving way for another round of rate cut in its next policy review,” Guha said.

The next meeting of RBI's monetary policy committee (MPC) is slated for early April.

Market analysts said RBI may also be hoping to increase private consumption by making available more liquidity in the system, and thus spur the economic activity at a time of the government grappling with the sagging growth rates.

Performance of the economy will be a major issue in the forthcoming elections, though Prime Minister Narendra Modi’s government and party BJP have been trying to project national security as the major focus in its election campaign, following India’s recent air strike against Pakistan.

It is the timing of the RBI’s decision to pump in additional liquidity that has surprised many market players as it comes with India’s general election is just round the corner.

Infusion of additional liquidity is bound to increase cash circulation and transactions in the market.

Historically, cash plays a major role in India’s elections. Police and Election Commission officials used to seize tons of cash from candidates of different political parties during every election, whether in states or parliamentary elections. 

“During election time, part of the liquidity in the market gets diverted for election funding,” said M R Rajaram, a leading financial consultant.

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