Context:
The Reserve Bank of India (RBI) plans to buy ₹1.25 trillion in government bonds, coupled with a ₹1.5 trillion dividend transfer to the Union government in May. This will likely increase surplus liquidity in the banking system, expected to reach ₹5 trillion by June 2025.
Impact on Lending Rates
- Banks poised to lower lending rates: As liquidity surges, banks will have more funds available to lend, which could lead to a reduction in lending rates—a shift that has been difficult for banks until now due to earlier liquidity constraints.
Liquidity Conditions and Market Response
- RBI’s proactive approach: RBI’s actions are designed to ensure that banks can pass on rate cuts without negatively affecting their margins. The central bank’s efforts are based on feedback from banks, which indicated that surplus liquidity was necessary to facilitate lending rate reductions.
- Interbank funding costs: The overnight call money rate, which is a key indicator of interbank funds, dropped to 5.87%, below the repo rate of 6%, and is expected to decrease further to 5.75%.
Economists’ View on RBI’s Bond Purchases
- Unprecedented bond purchases: Economists have described RBI’s bond-buying spree of ₹5.3 trillion in 2025 as unprecedented, pointing out that previous large purchases took over six quarters, especially during the post-COVID period.
Impact on Retail Lending
- MCLR adjustments: With increased liquidity, banks are expected to reprice retail loans more quickly, thus reducing the marginal cost of lending rates (MCLR). Many retail and small business loans are tied to MCLR, meaning that the influx of liquidity could directly lead to lower interest rates for consumers.
