Overnight rates ignore RBI rate cut

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 per cent on January 15. Yet, the interbank overnight cash rate is trading at eight per cent and above. That indicates high demand for cash. The volume of short-term funds that banks borrow from RBI has remained near a one-month high, set on January 14.

Banks have also been borrowing from RBI's emergency funding window, the marginal standing facility, on a daily basis. Traders say conditions are unlikely to ease as the government cuts spending to meet its deficit target for the financial year ending in March. Conditions could loosen in the new financial year when the government is expected to resume spending. 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.