The Indian central bank took action to "set a floor" for overnight interest rates, conducting reverse repo operations worth trillions of rupees to mop up liquidity to prevent inflation.

On Tuesday, the Reserve Bank of India (RBI) announced plans to withdraw 1 trillion Indian Rupees (approximately $116 billion) through variable rate reverse repo agreements on June 27th. In the previous few months, key financing rates and short-term rates have remained lower than the central bank's main policy rate, which may lead to asset mismatches. Analysts point out that the RBI's decision to withdraw liquidity from the financial system aims to prevent overnight lending costs from further declining. Policy makers need to consider both supporting economic growth, curbing inflation, and avoiding the situation where low market rates push up inflation pressure again. Sneh Pandey, a fixed income fund manager at Quantum Asset Management, said that the RBI's cautious approach aims to strengthen policy transmission and mitigate inflation risks. In the past two months, overnight rates have mostly been 20-25 basis points lower than repo rates, and the shortest-term government bond yields have been about 15 basis points lower. The rates being lower than the policy rate is partly due to the record liquidity injection of over 9.5 trillion Indian Rupees by the RBI since January. The withdrawal of liquidity measures led to a sell-off of short-term bonds on Wednesday, with the yield of a bond maturing in 2029 with a coupon rate of 6.75% rising by 4 basis points to 6.03%, and interbank rates rising by 5 basis points to 5.32%. Abhishek Upadhyay, senior economist at ICICI Securities, mentioned that initiating operations with a 7-day term instead of daily reverse repo operations signals that the RBI is not in a hurry to pull the overnight rate to the repo rate level, with the main intention being to set a floor for the overnight rate. Last week, RBI Governor Shaktikanta Das mentioned in an interview that the central bank will weigh whether to keep the overnight market borrowing rate near the benchmark repo rate or lower it to the lower limit of the interest corridor. The interest corridor set by the RBI manages short-term borrowing costs and guides liquidity in the banking system. It requires the overnight borrowing rate to align with the benchmark rate. The corridor includes three key rates: the current benchmark repo rate is 5.5%; the upper limit rate is 5.75%, the highest rate at which banks can borrow overnight from the central bank; and the lower limit rate is 5.25%, the lowest rate at which banks can deposit excess funds with the central bank. Sonal Varma, Chief Economist for Nomura Holdings Asia (excluding Japan), stated that the key point is that while the RBI wants policy transmission to be faster (with sufficient liquidity often being a prerequisite), they do not want a huge excess of liquidity that would push the overnight rate close to the lower limit of the interest corridor.