Indian overnight cash rates rose to 10 per cent on Wednesday and the government and central bank were readying to take more steps to ease tight liquidity, while state-run banks stepped in to buy rupees as the currency fell.
The Reserve Bank of India (RBI) also said it would offer a special funding window, introduced on Tuesday to help mutual funds meet their liquidity needs, on a daily basis until the cumulative limit of 200 billion rupees ($4.1 billion) was reached.
Finance Minister Palaniappan Chidambaram told a briefing in New Delhi that interbank lending remained constrained and it was necessary to overcome those constraints.
"The government and the RBI are agreed on the measures that have to be taken immediately," he said without detailing the steps but adding he expected to brief again later in the day.
Overnight interbank lending rates rose to about 10 per cent on Wednesday, a full percentage point above the central bank's main short-term lending rate of 9 per cent, after closing at 8.75/9.00 per cent on Tuesday.
A money market dealer at a foreign bank said heavy dollar selling by state-run banks, likely on behalf of the central bank to shore up the falling rupee, was adding to the cash crunch.
The benchmark 10-year bond yield jumped to 7.95 per cent from 7.88 per cent earlier after the finance minister's comments, as traders began to anticipate more monetary action to free up cash.
The central bank cut the percentage of deposits it requires banks to hold in reserve on Saturday by a hefty 150 basis points, releasing about $12 billion into the banking system.
Traders speculated the central may again lower the requirement, known as the cash reserve ratio, or cut the statutory liquidity ratio (SLR), which is the ratio of government bonds banks must hold as a percentage of their total deposits, or a mix of both.
The SLR is currently at 25 per cent.
The partially convertible rupee slipped on expectations foreign investors would withdraw money from India's stock market, as share markets across Asia fell on expectations of lower corporate earnings in a weakening global economy.
The benchmark share index was down 3 per cent and the rupee, which hit a record low of 49.30 per dollar on Friday, was trading 0.8 percent weaker on the day at 48.45/4650 even after state banks were seen selling dollars at 48.58-48.60.