Going into the pandemic, monetary policy in India was already accommodative. The RBI had reduced the policy repo rate by 135bps in the calendar year 2019. And the money markets were also in a surplus liquidity situation. But through the course of the pandemic, three things changed: firstly, the repo rate was reduced by another 115bps to 4%. Second, the spread between the repo rate and the reverse repo rate was widened to 65bps from 25bps before the pandemic. And thirdly, the surplus liquidity in the system expanded even further.

As a result of this, money market interests were far lower than what they would be under ‘normal circumstances.’ Under normal circumstances, the repo rate is the rate around which money market rates hover. The inter-bank call rate is benchmarked against the repo rate as a tool for measuring the effectiveness of RBI’s liquidity management. But a confluence of the factors discussed above meant that money market interest rates were not just below the repo rate they were well below even the reverse repo rate. On several occasions, money market rates were 100bps below the repo rate!

This was until now. Last few weeks, money market rates have risen sharply and there some semblance of normalcy has started to return.

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