A liquidity crisis in India sends interbank funding rates skyrocketing

The weighted average call rate, a day-to-day funding rate set by the central bank, rose to 6.78%, above the upper band of interest rates of the Reserve Bank of India at 6.75%.

This rise in funding costs in the Indian money market, caused by a liquidity crunch, should discourage the central bank from raising the policy rates. Indeed, this move is equivalent to a rate hike, even if the RBI has paused its monetary policy since April.

The rate hikes by the FED and persistent tensions in the Western financial system are affecting emerging markets. Cash reserves held by banks with the RBI have shrunk by nearly $10 billion compared to last year, causing funding costs to rise. In the short term, the liquidity crunch should ease, with the central bank expected to add liquidity to the financial system.

Apart from India-specificities, this incident also shows that lowering short rates by the central bank does not necessarily mean lowering funding rates. The U-turn of the FED and the pause in the rate hike movement displayed during the last FOMC are not the best of omens.

The current pressures on the American financial system could lead to the same consequence on the SOFR.

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