RBI likely to hold interest rates, thanks to excess liquidity

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Reserve Bank of India (RBI) governor Urjit Patel would most probably not change interest rates to handle the slowdown in economic growth, partly because excess liquidity in the banking system is already doing the job.
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There is more than $60 billion of excess liquidity in banks, even though it has been around seven months that the government played its demonetisation card. In the meanwhile, RBI raised the reverse repurchase rate in April and deployed an array of instruments that could help soak up the funds.

The excess liquidity has resulted in the growth being at its slowest pace in two years, inflation at a record low and loan demand the weakest in at least 25 years.

The level at which banks lend to one another on an overnight basis, known as weight average of the call money rate has also been about 6% this year, which is lower than the RBI's 6.25% benchmark repurchase rate. As per SBI Funds Management, this is equivalent to a reduction in borrowing costs.

"The RBI hasn't been very aggressive in taking liquidity out from the banking system and if the liquidity is going to be like this, then it means they are fine with overnight settings meaningfully lower than the policy rates," Rajeev Radhakrishnan, Mumbai-based head of fixed income at SBI Funds told Bloomberg. "If your overnight rate is lower than the policy rate for a long time, that's an indirect easing.''

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Even though the economic growth declined to 6.1% in the January to March quarter, and there was a decline in consumer price gains to 2.99% in April, the RBI may not change the rates because it seeks anchor inflation at 4% on a sustainable basis.

It could also suspect higher interest rates from the Federal Reserve and would keep in mind the possible effect on financial markets.

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