Chart: Easy Liquidity Keeps T-Bill Yields Below Policy Rate

A large surplus of banking liquidity has meant that investors are parking funds in short-term treasury bills, pulling down the interest rate on these securities. For almost two months now, the coupon rate at short-term treasury bill auctions has remained below the benchmark repo rate.

At the latest auction yesterday, the 91-day treasury bill was sold at a coupon rate of 5 percent. This was once again lower than the repo rate of 5.15 percent.

Theoretically, in the current framework, the repo rate acts as single operative policy rate. The repo rate is an overnight rate at which banks can borrow from the central bank. As such, longer term rates should trade above the repo rate. However, banks park funds with the RBI at the reverse repo rate, which is currently 4.9 percent. Practically, the reverse repo rate becomes the floor in times of surplus liquidity.

Still, the central bank may see a prolonged period of t-bill rates remaining below the repo rate as a red flag.

“Liquidity in the system remains in a large surplus mode but due to the slowdown there is little demand for funding. As a result, money is flowing into short-term treasury bills,” said Soumyajit Niyogi, associate director at India Ratings and Research. “If short-term rates remain below the policy rate for an extended period of time, the RBI may see this as some kind of risk to financial stability and intervene.”

T-bill yields had moved lower in anticipation of a rate cut at the December policy meet. The monetary policy committee, however, surprised by keeping rates unchanged. Still, it maintained an accommodative stance and Reserve Bank of India Governor Shaktikanta Das described the pause as temporary.

This accommodative stance with the possibility of further rate cuts may justify t-bill rates remaining below the policy repo-rate, said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. Ltd.

“With the MPC maintaining an accommodative stance and liquidity in large surplus, it is not surprising that t-bill yields are below the repo rate,” Chari said. “At this stage, this may not be a concern for the central bank but should it persist with the MPC remaining (intending to remain) on hold, the RBI may consider intervening.”