A recent report highlights the persisting cash crunch caused by a rise in the Weighted Average Call Rate (WACR), pushing short-term borrowing costs above a key policy interest rate.
Yield Curve Inversion Raises Concerns
In addition to the cash crunch, the report also reveals an inversion in the yield curve, with the yield on one-year treasury bills surpassing that of 10-year government bonds. Yield curve inversion is often associated with a malfunctioning bond market and has historically been viewed as an indicator of an impending economic recession.
Funding Squeeze and Its Implications
The funding squeeze indicates a strained financial system that is negatively impacting the demand for bonds and increasing financing costs. This situation arises as the Reserve Bank of India (RBI) has paused monetary tightening efforts amid easing price pressures.
Lingering Challenges and RBI’s Approach
Economists predict that the current situation may persist for some time, as the RBI is expected to focus on liquidity management rather than injecting permanent liquidity. While the RBI aims to rein in inflation and provide a buffer for the local currency, the tight financing conditions pose challenges for firms with weaker credit profiles, potentially leading to clustered credit events and contagion effects.
The Indian economy, which has seen remarkable development since the pandemic but now faces challenges from sluggish global demand and a heatwave affecting the agricultural industry, is at risk if the cash crunch continues to worsen.
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