Indian central bank governor Urjit Patel is unlikely to cut interest rates to tackle a growth slowdown excess liquidity in the banking system is already doing the job for him.

The Reserve Bank of India is still grappling with more than $60 billion in excess liquidity after the government’s crackdown on high-denomination notes last year, even after raising the reverse repurchase rate in April and deploying an array of instruments to soak up the funds. With growth at the slowest pace in two years, inflation at a record low and loan demand the weakest since at least 1992, that liquidity is coming in handy.

The weighted average of the call money rate, the level at which banks lend to one another on an overnight basis, has been about 6 percent this year, lower than the RBI’s 6.25 percent benchmark repurchase rate. That’s equivalent to a reduction in borrowing costs, according to SBI Funds Management Pvt.

“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,” said Rajeev Radhakrishnan, Mumbai-based head of fixed income at SBI Funds, a unit of India’s largest lender. “If your overnight rate is lower than the policy rate for a long time, that’s an indirect easing.’’

Despite the deceleration in growth to 6.1 percent in the January to March quarter and a slowing in consumer price gains to 2.99 percent in April, the RBI may stand pat on Wednesday as it seeks anchor inflation at 4 percent on a sustainable basis. The monetary authority may also be wary of higher interest rates from the Federal Reserve and its impact on financial markets.

Change Tone

Of the 50 economists surveyed by source News, 48 expect the central bank to keep the repurchase rate on hold. Only two, including source Intelligence analyst Abhishek Gupta, expect a quarter-percentage point rate cut in the repo and the reverse repo rate.

“When people are saying the RBI is getting it wrong and they need to cut rates, they also need to remember that monetary policy is actually quite loose,’’ said Suyash Choudhary, Mumbai-based head of fixed income at IDFC Asset Management Co. The “market needs to realize that barring commentary, the RBI policy is quite easy given that it’s backed by so much surplus liquidity being allowed to remain in the system.”

Banks are holding almost 4 trillion rupees ($62 billion) of surplus cash, according to the source Intelligence India Banking Liquidity Index, albeit down from a record 5.5 trillion rupees in March. The system was flooded with money after Prime Minister Narendra Modi’s demonetization move in November. Meanwhile, banks are saddled with soured loans and over-leveraged companies are reluctant to borrow after a decade-long investment binge.

Still, economists say the central bank may tone down its hawkish rhetoric and may be prompted to deliver a rate cut in the coming months if the data continues to soften, traders said. That has led to rally in Indian bonds, with the yield on the benchmark 10-year notes dropping to 6.64 percent.

“We believe that its time the RBI adjusts its inflation forecasts to strengthen its credibility,”Pranjul Bhandari, chief India economist at HSBC Holdings said in a note. “We continue to expect the RBI to be on a prolonged pause but with risks of a 25 basis point rate cut in August if certain conditions are met.”

The RBI will probably revise down its inflation forecasts, but at the same time it will remain cautious about price pressures, said Mahendra Jajoo, who oversees almost 10 billion rupees in assets as head of fixed income at Mirae Asset Global Investments (India) Pvt. “That should make bond markets happy.”


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