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The liquidity in the banking system has turned deficit to a record high of Rs 3.4 lakh crore on Wednesday due to moderation in government spending, higher tax outflows and slower bank deposit growth.
Analysts expect the Reserve Bank of India (RBI) to announce permanent liquidity measures such as open market operations (OMO) purchases to ease liquidity deficit conditions in the banking system rather than variable repo rate auctions (VRR) to infuse temporary liquidity.
“The primary reason for this (liquidity deficit) is that the government is not spending much. Also, this week is when the goods and services tax (GST) outflow happens,” said a treasury head of a private sector bank.
Banking system liquidity, as reflected by the amount of money injected by the RBI into the banking system, has been in deficit mode since last month after advance tax and goods and services tax (GST) payments.
On a net basis, the RBI has injected liquidity averaging Rs 1.8 trillion between December 16, 2023 and January 14, 2024.
Higher outflows from foreign portfolio investors (FPIs) have also led to the widening of banking system liquidity, analysts said. So far in the current month, FPIs have pulled out Rs 19,308 crore of local shares on a net basis in January so far, according to data from National Securities Depository Ltd (NSDL).
According to Madan Sabnavis, Chief Economist, Bank of Baroda, the liquidity tightness is a case of deposits rising at a slower pace compared to the growth in credit.
In the fortnight ended December 29, the bank deposits grew by 13 per cent on a year-on-year (y-o-y) basis, while credit grew by 20 per cent, the latest RBI data showed. The growth includes the impact of the merger of HDFC with HDFC Bank.
A large amount of retail deposits migrating to mutual funds has also resulted in a slower growth in deposits, Sabnavis said.
The RBI has been conducting VRR auctions to infuse liquidity into the banking system. Between December 16 and January 14, it conducted five variable rate repo (VRR) auctions of 2-7 days maturity and a main operation (13 days) amounting to Rs 1.75 lakh crore. On January 24, the RBI announced a 15-day VRR worth Rs 2.5 lakh crore.
Bankers said the RBI wants liquidity to remain in the deficit mode as consumer priced-based inflation (CPI) continues to remain above its target of 4 per cent. Retail inflation, or CPI, edged up to 5.7 per cent in December 2023 from 5.6 per cent in November.
If the ongoing liquidity conditions persist, the RBI will necessarily have to infuse more durable liquidity into the banking system, India Ratings and Research (Ind-Ra) said in a report.
“Sustained tightness in the banking system liquidity could prove to be onerous for borrowers and will worsen in case if government spending does not accelerate in a meaningful way. Therefore, the infusion of durable liquidity is becoming necessary and idealistically, the monetary policy stance should change to ‘neutral’ from ‘withdrawal of accommodation’ to maintain consistency of stance and action,” said Soumyajit Niyogi, Director, Core Analytical Group, Ind-Ra.
While an increase in FPI inflow owing to the inclusion in Global Bond Indices will improve the liquidity situation, the surge in cash-in-circulation ahead of the parliamentary election will keep the RBI on toes, notwithstanding the beginning of government spending in April 2024 and relatively weak credit season, the rating agency said.
