The Indian money market remains the primary channel through which banks, financial institutions, and large corporates access short-term funding. The certificates of deposit (CDs) issued by banks, and the commercial papers (CPs) issued by financial and corporate entities form its core supply, with mutual funds serving as the dominant investor base.

In recent months, the market has entered a phase marked by elevated CD issuance, persistently wide spreads, sharply reduced corporate CP supply, and long-standing low liquidity in the secondary market. Unlike the stress seen during the post IL&FS period (2018–19), the current environment is not precipitated by credit concerns.

Rather, it reflects the interaction between the structural shifts in investor behaviour, regulatory liquidity requirements for banks, mutual fund seasonality, and portfolio construction constraints within the MF industry.

CD issuance

Since mid-2023, system liquidity has gradually moderated after the post-Covid surplus. Meanwhile, credit demand has revived meaningfully.

Bank credit — which had slowed to 9 per cent in May 2025 — rebounded to about 15 per cent by mid-April this year, prompting many banks to upgrade their FY27 credit growth guidance.

With credit growing faster than deposits, banks increasingly turned to CDs as a wholesale funding tool. Outstanding CDs nearly doubled from around ₹3 lakh crore at the start of 2023 to nearly ₹6 lakh crore by January and ₹7 lakh crore by April. This was amplified by quarter-end balance sheet considerations and rising loan demand.

CD spreads relative to 3-month T-bills widened sharply. After softening during the first half of 2025, following policy rate cuts, the spreads rose from 30–40 bps in mid-2025 to 75–80 bps by the year-end, and touched 220 bps by February-March.

These spreads have eased to 100-120 bps in April, as part of seasonal adjustments, but still remain significantly elevated on a year-on-year basis. There are structural supply-demand mismatches.

CD supply

Even as banks actively issue CDs, corporate CP issuance has moderated. Many corporates find bank working capital lines — linked to external benchmark lending rates such as T-bill-based formulas — cheaper than issuing CPs. This has made bank borrowing more cost-effective than market borrowing.

Weak appetite

Mutual funds remain the primary investors in CDs and CPs, but their deployable AUM for these instruments has not kept pace with the rising supply. SEBI’s duration- and credit-based categories limit fund flexibility during volatile periods.

For example, liquid funds cannot buy papers beyond 91 days. Overnight funds can invest only in one-day instruments like the tri-party repo dealing system (TREPS). Equity/hybrid funds maintain cash for margins but cannot use it for longer-tenor CDs/CPs. Consequently, headline liquidity — like the large overnight TREPS market — overstates actual MF capacity to invest in money market instruments.

AUM reallocation

The taxation changes for debt mutual funds in Budget 2023 have significantly reduced the post-tax attractiveness of debt funds for retail investors. Flows have since shifted.

Retail investors prefer equity/hybrid categories. Debt fund flows have become predominantly institutional. AUM growth has concentrated in overnight funds, used mainly for corporate treasury management.

Medium- and long-duration debt fund categories have stagnated or seen outflows. This makes AUM inherently more volatile and reduces demand for CDs and CPs.

Bank bulk deposits

As banks chase both CASA (current account and savings account) and term deposits, they have also been mobilising bulk deposits, which compete directly with MF liquid schemes. Bulk deposits offer stable returns without mark-to-market volatility — appealing to many corporates. This has diverted flows away from the MF schemes that typically invest in CDs.

Illiquidity

Despite large outstanding volumes, secondary trading in CDs and CPs remains limited and concentrated in short residual maturities and top-rated issuers. Long-term investors like insurers and provident funds largely stay away from this segment.

With banks participating mainly for the management of liquidity coverage ratio (LCR), mutual funds often become the only active secondary traders. The redemption patterns across fund houses are also synchronised, resulting in simultaneous selling pressure and thin bid-side depth. This pushes funds toward diversified, conservative portfolios and reinforces a hold-to-maturity bias. The CP market is the most illiquid, further demanding additional spread for liquidity risk.

Seasonal patterns

Seasonality also influences short-term rates. Each March (and other quarter ends), corporates withdraw 20–25 per cent of liquid fund AUM for tax and balance sheet requirements. These funds typically return in April, pushing down short-term yields. Ahead of March, MFs avoid buying 3-month papers to reduce reinvestment risk, causing tenor mismatches and temporary spread spikes — even when the system liquidity is otherwise stable.

CD spreads

Some moderation in CD spreads is likely post the March redemption cycle. However, sustained credit growth ensures continued funding needs for banks.

With short-tenor CD rates rising sharply, banks may increasingly shift toward longer-tenor infrastructure and Tier II bonds — supported by renewed infra eligible assets — especially since long-term investors like provident funds prefer such instruments. This could gradually ease the pressure on CD spreads.

Elevated CD spreads reflect the equilibrium of strong bank funding needs, muted institutional demand, and persistent secondary market illiquidity. Absent broader participation or new liquidity mechanisms, and supply-demand mismatches will continue to shape short-term rate behaviour in India’s money market.

(Rajeev Radhakrishnan is CIO–Fixed Income, Mansi Sajeja is Fund Manager, and Namrata Mittal is Chief Economist, SBI Mutual Fund)

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Published on May 11, 2026