Liquidity in the banking system will create its own dynamic around good quality assets and ensure safe returns on investments
RBI Governor Urjit Patel. There does not seem to be much leeway for the central bank to cut interest rates aggressively
Image: Dhiraj Singh / Bloomberg via Getty Images
Banks are likely to wait until March to get more clarity on residual liquidity
The second aspect to ponder over is what demonetisation has done for India’s banking system and its implications for the fixed income market. The biggest challenge that the monetary policy faced was lack of transmission. The Reserve Bank of India (RBI) was reducing interest rates, but the banks were not willing to pass them on due to a variety of factors. At the heart of it—which got articulated before former RBI governor Raghuram Rajan left—was the fact that while the RBI turned the monetary cycle from a tightening cycle to an easing cycle, systemic liquidity continued to be very tight. That created a floor for reduction in rates by banks. The RBI then said it would try and normalise the liquidity from a deficit mode.(This story appears in the 03 March, 2017 issue of Forbes India. To visit our Archives, click here.)