RBI’s rate hike influenced by external factors

Subject : Economy

The RBI raised its ‘repo rate’ under Liquidity Adjustment Facility (LAF) from 5.90 to 6.25 per cent on December 7.
It is the 5th consecutive hike in the RBI’s main policy rate.
It is linked to the developments in the external sector like net negative foreign investment and decline of net forex reserves.
Plotting the ‘call money rate’ in India along with the US ‘federal funds rate’ reveals close movement in between them.

Call Money Rate

Call money rate is the rate at which short term funds are borrowed and lent in the money market.
Call money deals with day to day cash requirement of banks.
Banks that are faced with cash shortage borrow from other commercial banks for a period of 1-14 days.
When banks borrow for one day it is known as call-money.
Any money borrowed for more than 1 day but maximum of 14 days is known as notice money.
The rate at which these transactions take place is known as the call rate.
Thus, banks resort to call money to fill temporary mismatches in funds and maintain short term liquidity. It is the central point by which RBI is able to influence interest rates.
RBI, banks, primary dealers etc are the participants of the call money market. Demand and supply of liquidity affect the call money rate.
A tight liquidity condition leads to a rise in call money rate and vice versa.