RBI seeks market view on aligning short-term rates to repo rate

Mumbai, June 17, 2025 — The Reserve Bank of India (RBI) has opened consultations with financial market participants on a key monetary policy consideration: whether short-term interest rates should be more closely aligned with the repo rate, its primary policy rate. This move could significantly influence the way liquidity is managed in the economy and enhance the transmission of monetary policy to broader markets.

A Push for Stronger Policy Transmission

At the heart of this initiative is the RBI’s ongoing effort to refine its monetary transmission mechanism—the process through which policy rate changes influence borrowing costs, investment activity, and ultimately, economic growth. The repo rate, currently at 6.50%, serves as the benchmark for overnight lending to commercial banks. However, market-determined short-term interest rates such as the overnight call money rate and the 91-day Treasury bill rate often diverge from the repo rate, creating inefficiencies in the policy framework.

"Efficient transmission is critical for effective monetary policy," said an RBI official familiar with the matter. "We are exploring whether better alignment of operating rates with the policy rate can support our inflation-targeting framework and macroeconomic objectives."

RBI's Discussion Paper Highlights Structural Issues

A discussion paper released by the central bank outlines several options to narrow the gap between short-term market rates and the repo rate. These include reconfiguring the liquidity framework, enhancing fine-tuning operations such as variable rate reverse repo (VRRR), and possibly re-examining the role of the Standing Deposit Facility (SDF) and Marginal Standing Facility (MSF) corridors.

According to the paper, “The widening and persistent deviation of the weighted average call rate (WACR) from the repo rate undermines the signaling channel of monetary policy. There is a case to calibrate the liquidity conditions and rate corridor to restore symmetry and effectiveness.”

Analyst Views: Timing is Critical

Market analysts have welcomed the consultation but caution that any realignment must be delicately timed and transparently communicated.

"While the repo rate is the anchor, the operative target of monetary policy has been more variable due to shifting liquidity surpluses or deficits," said Radhika Rao, Senior Economist at DBS Bank. "Aligning short-term rates could reduce volatility, but the RBI must ensure there are no liquidity shocks that might affect market confidence."

Echoing a similar view, Jayesh Mehta, MD of Treasury at Bank of America India, noted, "This could be a game changer in reinforcing the RBI's intent. But managing market expectations will be key, especially with global uncertainties and inflation pressures still simmering."

Implications for the Bond Market

The proposed alignment could have far-reaching implications for India’s fixed income markets. A tighter correlation between short-term rates and the repo rate could lead to more predictable interest rate movements and enhance the attractiveness of government securities (G-Secs).

"If the RBI manages to align the short-term curve, it will bring more clarity and stability to the bond market," said Mehul Desai, fixed income strategist at Kotak Securities. "However, liquidity must remain adequate, or else bond yields may spike unexpectedly, especially in the shorter tenors."

The move may also influence the behavior of mutual funds, corporate treasuries, and banks, especially in their short-term deployment strategies. Greater predictability in funding rates can encourage more robust demand for T-bills and commercial paper (CP), thereby improving liquidity in these segments.

Background: Learning from Global Peers

Several global central banks, including the U.S. Federal Reserve and the European Central Bank (ECB), use operating targets such as the federal funds rate or the deposit facility rate to guide short-term rates effectively. The RBI's exploration of similar alignment suggests a convergence with best practices in advanced economies.

"Globally, there's a strong case for narrowing the gap between target and market rates to strengthen the signaling of monetary policy. India is now rightly assessing if the time is ripe for such a shift," said Priya Nair, economist at JP Morgan India.

Challenges Ahead

Despite the apparent benefits, the central bank will have to address operational and structural challenges. These include managing capital flows, evolving liquidity conditions, and the risk of market disruptions in times of uncertainty.

Moreover, the RBI must strike a balance between control and flexibility. While tighter alignment could make policy more potent, it may reduce the central bank’s agility in responding to unforeseen shocks.

“There’s a trade-off,” said Vivek Sharma, macro analyst at ICICI Securities. “Overengineering could constrain the system, especially during episodes of capital flight or fiscal slippage.”

Investor Outlook: A Mixed Bag

For investors, the RBI’s move signals a more proactive stance in enhancing transparency and predictability. Short-term debt funds, T-bill investors, and corporate treasuries may benefit from reduced rate volatility. However, any premature or overly rigid implementation could cause temporary dislocation, especially if market participants are not adequately prepared.

"Investors should watch liquidity trends and RBI’s fine-tuning operations in coming months," advised Kavita Krishnamurthy, fund manager at HDFC Mutual Fund. “We expect a gradual, calibrated approach, which should support portfolio rebalancing in the short-duration segment.”

What’s Next?

The RBI has invited feedback from market participants, including banks, NBFCs, mutual funds, and policy think tanks. The consultation window remains open for the next four weeks, following which the central bank may issue a revised operational framework or initiate pilot measures.

As the RBI walks this tightrope between policy ambition and market realism, the financial sector will be closely watching how this critical evolution unfolds.

The Reserve Bank of India's deliberation on aligning short-term interest rates with the repo rate marks a pivotal moment in the evolution of India's monetary framework. While the move could sharpen policy transmission and improve market efficiency, its success hinges on timing, communication, and coordination with broader fiscal and global conditions. Investors and market participants should prepare for a new era of more synchronized interest rate dynamics—one that could redefine the way liquidity and risk are managed in the Indian financial system.