Run up to MPC review: RBI actively focusing on policy rate transmission

Amid fiscal consolidation, heavy lifting by central bank to support economy

With a liquidity infusion of close to ₹8 trillion in the last three months, and showing intention to do more, the Reserve Bank of India (RBI) seems to be in a hurry to speed up monetary transmission of policy rates to the lending and deposit rates by easing financial conditions.

 

Bond prices surged after the central bank’s surprise announcement of ₹80,000 crore open market operation (OMO) to pump liquidity into the banking system by purchasing bonds in April, with the 10-year benchmark yield declining 10 bps on Wednesday to close at 6.48 per cent, the lowest level in three years.

 

The bond purchase move is seen as a proactive step ahead of the monetary policy committee (MPC) review next week where the rate-setting panel is widely expected to deliver another 25 basis points (bps) rate cut. The central bank is seen to be preparing the ground for monetary transmission before cutting the policy repo rate.

 

“We think the RBI is now actively targeting abundantly surplus liquidity in order to ensure transmission of the rate-cutting cycle,” said Suyash Choudhary, head-fixed income, Bandhan AMC.

 

“It is clear that the RBI is proactive in creating enabling conditions for transmission,” Choudhary added. 

 

Latest data released by the RBI shows that the impact on lending and deposit rates was minimal despite a 25 bps cut in policy repo rate, mainly due to tight liquidity conditions.

 

The weighted average lending rate (WALR) on fresh rupee loans of scheduled commercial banks (SCBs) stood at 9.40 per cent in February 2025 as compared 9.32 per cent in the previous month while WALR on outstanding rupee loans of SCBs declined to 9.80 per cent in February from 9.87 per cent in January.

 

The 1-year median Marginal Cost of Funds-based Lending Rate (MCLR) of SCBs declined to 9.00 per cent in March 2025 from 9.05 per cent in the previous month.

 

Similarly, the weighted average domestic term deposit rate (WADTDR) on fresh rupee term deposits of SCBs stood at 6.48 per cent in February as compared to 6.56 per cent in January.

 

Typically, it takes two quarters for full monetary transmission of policy rates.

 

“In our view, the RBI is fully aware that a rate cut amid a liquidity deficit is akin to a ‘wasted bullet’ and is thus rightly setting the stage for (potential) effective transmission by infusing liquidity into the system in the run-up to the April 9 policy. In our view, the RBI is choosing the liquidity path to indicate an 'accommodative' stance, even as it stays optically 'neutral',” economists at Barclays said in a note.

 

The decision to announce the OMO on Tuesday was taken even after the banking system liquidity turned surplus in the last few days — after a gap of more than four months.

 

“The most important aspect, which is helping to make the liquidity conditions easier, is the acknowledgement of the fact that the RBI balance sheet growth was very weak last year because of the significant intervention in the foreign exchange (forex) market. Reserve money growth was weak,” Devang Shah, head of fixed income, Axis Mutual Fund, told Business Standard during an interaction.

 

“Rate cuts will not be effective until and unless you have surplus liquidity. Our view is from here till September, liquidity should remain in surplus,” Shah said.

 

The RBI’s surplus transfer to the government, which typically happens in the first quarter, will also help improve the liquidity situation.

 

“In our estimate, ‘core’ system liquidity, defined here as headline liquidity minus cash balances run by the government, has already turned positive, approximately ₹2 trillion, as of the end of the March quarter. This is due to proactive steps taken by the central bank over the past two months. Further, with new steps announced and an expected large dividend due from the RBI to the government in May, we expect core liquidity to be surplus by almost ₹4.5 trillion by end of May,” Choudhary of Bandhan AMC said.

 

“The liquidity surplus is likely to continue to increase as the latest OMO purchase follows through, further supported by the upcoming bumper RBI dividend at end-May,” the Barclays note added.

 

Interestingly, at a time when the government is following a path of fiscal consolidation, it is the central bank which has to do the heavy-lifting on growth, with all the liquidity measures and interest rate cuts.

 

“We also need to highlight the fact that India is the only economy which is continuously following a fiscal consolidation path,” Shah said.

 

“There are two levers to support the economy. Either you take the fiscal pill, or monetary impulse. We have been doing fiscal consolidation. So, a lot of it is left to the RBI to get the monetary impulse to support the economy,” Shah added.

 

It is to be seen if banks are taking the cue from the RBI to start dropping lending and deposit rates amid margin compression concerns.