Indian monetary policy and the fine art of acting without acting

livemint.com:

₹29,287 crore during April-September, hitting a peak of ₹198,730 crore on 21 September. Subsequently, RBI’s liquidity operations show that banks have borrowed an average of over ₹125,000 crore every day under MSF for the seven days between 25 September and 1 October.

While this spike might be temporary and reflective of banks unable to plan for flux in system liquidity, it might be worth asking whether banks will try to pass on this temporary cost to borrowers. Given that RBI will continue to suck out surplus liquidity, and that many banks will still queue up outside the MSF window for tiding over temporary cash flow imbalances, there is a likelihood that the MSF rate could become the effective benchmark rate.

The weighted average call money rate has already moved up from 6.44% on 8 September to 6.75% on 29 September. There are also indications that RBI’s complaints of incomplete rate transmission might be heeded via the bond market.

The central bank announced that it will deploy open market sales of government bonds, as an additional instrument, to soak up surplus liquidity in the system. Open market operations might have become necessary given the seeming misalignment between RBI’s liquidity absorption strategy and tools, and the banking sector’s liquidity calculations and other aspirations.

The bond market reacted to the news with the benchmark 10-year G-Sec yield jumping 13bps to 7.34%, a considerable spike in a single day. If this spurt is not transient and not extinguished pre-maturely by RBI, then there is a faint likelihood that higher bond yields could translate into higher lending rates; the transmission path for this is likely to be indirect and uncertain because few banks use the 10-year government bond yield