CD rates diverge as liquidity surges, rate hike bets rise

Mumbai: A surge in banking liquidity due to inflows during the special central bank window to mobilise foreign currency deposits and expectations that interest rates are on their way up are causing the rates of short- and long-term certificates of deposit (CDs) to move in opposite directions.

The gap between one-month and one-year CDs is the widest at least since June 2022, as banks price in higher rates in the medium term, while the massive liquidity from inflows of foreign currency non-resident (FCNR) deposits results in short-term rates coming down.

The rates are around 5.75-5.80% for one-month CDs compared with 7.50% for one-year deposits, as banks expect liquidity to be tight and rates higher one year from now. The difference, which now is 170-175 basis points (1.70-1.75 percentage points), was normally 70-100 basis points, bankers said.


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The large difference in the rates indicates that though the liquidity situation is conducive currently, the market does not expect it to continue this way and is pricing in at least a couple of rate hikes, said Soumyajit Niyogi, director of core analytical group at India Ratings & Research.

"Expectations are that the surplus will wither away over time," Niyogi said. "Interestingly, the spread in T-bills is also around 100 basis points, compared with the usual 50-60 basis points. This suggests that the pressure is not merely a function of the liquidity or interest-rate outlook but also points to a more structural challenge around deposit accretion in the banking system. The market is pricing in a terminal repo rate of 6%, which means two or three hikes this fiscal," he said.

The benchmark repo rate is currently 5.25% and a terminal rate, or the peak rate in this cycle, at 6% will mean at least three hikes of 25 basis points each.

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The money market has swung to a liquidity surplus of ₹5 lakh crore from a deficit before the Reserve Bank of India announced the special FCNR (Bank) scheme in June. Inflows under the scheme during the RBI window totalled $133 billion, flooding the banking system.

Bankers said extreme liquidity in the shorter end of the market depressed short-term rates while expectations that interest rates were headed higher were not allowing longer tenure rates to fall. "With the US Fed also hiking rates now, the market expects at least a couple of rate hikes from India too as inflation is inching up, global rates are higher and the rupee is also not totally under control," said Gopal Tripathi, head of treasury at Jana Small Finance Bank. "One thing is clear: money will become expensive in the medium term," he said.