India’s central bank on Wednesday indicated the level of liquidity needed to keep overnight rates closely aligned with the key policy rate. It reiterated that the weighted average call rate (WACR) serves as its operating target and should remain as close as possible to the repo rate. According to the RBI’s monetary policy report, maintaining a liquidity surplus between 0.6 percent and 1.1 percent of deposits would likely keep the gap between the WACR and the policy rate within 5 to 10 basis points. The central bank noted that while liquidity and the spread move in opposite directions, the relationship is not linear.

The RBI left the repo rate and policy stance unchanged. Governor Sanjay Malhotra emphasized that the central bank will remain proactive and forward-looking in managing liquidity, ensuring adequate funds to support the economy’s productive needs. On the other hand, a liquidity deficit of 0.4 percent to 0.7 percent of deposits could push the WACR above the repo rate by 5 to 10 basis points. The RBI added that while excess liquidity beyond a certain point has limited additional impact on narrowing the spread, deficit conditions can cause the spread to widen sharply.

Liquidity in the banking system recently rose above 4 trillion rupees, its highest level in eight months, pulling the WACR below 5.10 percent this month—more than 15 basis points lower than the repo rate of 5.25 percent. The central bank also observed that the effect of surplus liquidity weakens after a threshold, as the yield curve flattens with further increases. The RBI noted that aligning the WACR with the repo rate requires different liquidity levels depending on whether the system is in surplus or deficit, and the degree of alignment depends on the magnitude of that surplus or shortfall.