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Indian banks still battling rate cuts as liquidity row with RBI continues

At central bank’s last review on April 5, Rajan committed to erasing the liquidity deficit to near zero

Policy Pulse
Publish Date: May 25 2016 1:27PM | Updated Date: May 25 2016 3:38PM

Indian banks still battling rate cuts as liquidity row with RBI continues

 Reserve Bank of India (RBI) has increased fund injections in two months since governor Raghuram Rajan promised to slowly remove cash deficit in the financial system, but commercial banks say it is still not sufficient for them to sharply lower interest rates. 

 
It  has slashed rates by 150 basis points (bps) since beginning of last year, taking policy rate to a five-year low of 6.50 percent, but country's banks have cut lending rates by less than half that, frustrating Rajan's efforts to recover weak private investment. 
 
Issue will be in focus at RBI’s policy review on June 7, when Rajan is expected to leave rates on hold. 
 
He has made clear his emphasis will now be on ensuring that the aggressive rate cuts over the last year are fed through to the economy. 
 
Bankers say there is not much liquidity in market for them to reduce rates and lend more easily while still being sure they can fulfill their liquidity requirements. 
 
At central bank’s last review on April 5, Rajan committed to erasing the liquidity deficit to near zero.
 
RBI has since injected $5.92 billion through open market operation (OMO) bond purchases, which excludes Wednesday's ongoing auction for 150 billion rupees. 
 
Alongside, central bank bought around 80 billion rupees from foreign exchange interventions. 
 
That should give market with enough liquidity for banks to lower rates and lend more, two RBI officials said. 
 
But bankers say it is still not much, and that stripping out provisional fluctuations India continues to have a daily core liquidity deficit of $14.81 billion, little changed since the RBI's pledge. 
 
These cash deficiencies upsurge banks' funding costs, making it harder for them to lower lending rates, according to bankers, who say they may press the issue with the RBI. 
 
"Neutral liquidity needs to be achieved as quickly as possible," said Ananth Narayan, regional head of financial markets for ASEAN and South Asia at Standard Chartered Bank. 
 
Yet RBI fears adding too much money into the system would spark inflation. 
 
The amount of currency in circulation has surged since October, mainly because of spending related to recent state elections. 
 
Cash withdrawals from banks hit 17.5 trillion rupees in the week ended May 13, the biggest weekly total in 15 years. 
 
RBI says the this money will at some point make it back into the financial system and that more cash injections now could result in excess liquidity. 
 
"Basically, the focus is on inflation control," said RBI officials. 
 
Bankers believe RBI can remove any excess liquidity through open market bond sales - something the central bank has been unwilling to do as it fears it would make inflation management more volatile. 
 
RBI's last open market operation bond sale was in July 2015.