The Reserve Bank of India has recently flagged a troubling trend ~ rising asymmetries in the shortterm money market rates that threaten the effectiveness of monetary policy transmission. In plain terms, the central bank is pumping liquidity into the system and adjusting policy rates to guide economic momentum, but the signals are getting lost in transmission. This disconnect between intent and impact could have ripple effects on credit flow, inflation management, and overall economic confidence.
At the heart of the concern is the call money rate ~ an overnight interest rate that reflects the cost of very short-term funds in the banking system. Alongside this are the market repo and TREPS (tri-party repo) rates, all critical to the smooth functioning of India’s money markets. Ideally, these rates should move in tandem with RBI’s policy direction. When they do not, it creates uncertainty and undermines the central bank’s ability to influence borrowing costs in the real economy. The central bank has done its part by injecting significant liquidity ~ averaging Rs 1.7 trillion daily this month ~ after a prolonged deficit phase.
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This should have eased funding pressures and led to a uniform softening of rates. That this is not happening points to deeper structural inefficiencies. Banks, which are the sole conduits of RBI’s liquidity operations, must take greater responsibility in ensuring that policy measures are quickly and uniformly transmitted across the spectrum of financial instruments. What makes this misalignment even more worrisome is that it is occurring during a period of surplus liquidity ~ a condition typically favourable for smoother rate transmission.
If systemic inefficiencies persist even in benign conditions, the risks during times of stress, such as global shocks or domestic financial tightening, could be far more severe. This is not just a technical issue for market participants to puzzle over. When monetary signals become garbled, it affects everything from home loan EMIs to working capital costs for small businesses. It weakens the RBI’s hand in stabilising inflation or spurring growth, especially at a time when global headwinds demand nimbleness and clarity in domestic economic management. But responsibility cannot rest with banks alone.
The RBI’s call for a broader, more liquid government securities market is timely. Deepening participation, particularly from non-bank players such as mutual funds, insurance companies, and foreign institutions, can improve price discovery and reduce reliance on a handful of dominant actors. Similarly, the derivatives market must mature to allow for more effective hedging and risk distribution.
Diversity of views and competition are not just virtues ~ they are necessities for a robust financial ecosystem. India’s financial markets have come a long way in the past two decades, but these recent signals are a reminder that the plumbing still needs fixing. Transparent, efficient, and responsive money markets are not optional in a modern economy ~ they are foundational. It is time all stakeholders ~ banks, regulators, and market participants ~ lean in with urgency and commitment. The credibility of India’s monetary framework depends on it.
