Overnight rates in India ignore RBI rate cut

By Swati Bhat

MUMBAI (Reuters) - India's financial system is facing a deficit in short-term funds even after a cut in the official lending rate last week, and bankers do not expect conditions to improve until April.

The Reserve Bank of India (RBI) reduced its key lending rate by 25 basis points to 7.75 percent on Jan. 15. Yet the interbank overnight cash rate - a key measure of cash conditions - is trading at 8 percent and above.

That indicates high demand for cash. The volume of short-term funds that banks borrow from the RBI has remained near a one-month high set on Jan. 14. Banks have also been borrowing from the RBI's emergency funding window, or the marginal standing facility (MSF), on an almost daily basis.

Traders say conditions are unlikely to ease as the government cuts spending to meet its deficit target for the fiscal year ending in March. Conditions may loosen in the new financial year when the government is expected to resume spending.

The RBI has been periodically selling dollars and buying rupees to prevent a sharp depreciation in the local currency, pulling out liquidity in the process. Free cash has also been scarce as banks park surplus money in government bonds to benefit from attractive returns, given the high rates on rupee deposits and sluggish demand for loans.

GRAPHIC: India liquidity: http://link.reuters.com/nuf83w

(Editing by Ryan Woo)