Indian money market dynamics

The short term market is an important source for banks and institutions to secure funds to align their short term asset liability mismatches. Central Banks use the market to signal policy stance changes. In India, Reserve Bank of India uses monetary policy not only to signal the policy stances but also uses the same to map growth dynamics of the economy. The short term rates generally synchronize with policy rates in a manner that helps smooth transmission of monetary policy. In India, the short term market heavily revolves around daily LAF of RBI as well as overnight inter-bank Call Money, Repo and CBLO markets. Effort to develop a term money market has not been very successful. The article looked at creating an indexed rate taking into account all three segments into consideration rather than picking up only one rate. The liquidity was estimated as ratio of LAF and Net Demand and Time Liability (NDTL). The relationship between indexed rate and liquidity was tested and found to be rational. The article also found rational relationship between the spread of Inter-bank Call and Repo and ratio of LAF and NDTL along with money market transaction volume