Liquidity likely to veer towards neutral after three years of surplus

Future scenario hinges on forex market, govt spending, credit growth

Ever since the Reserve Bank of India (RBI) undertook emergency measures to shield the economy from the Covid-19 crisis in 2020, liquidity in the banking system has broadly remained at a surplus, although the degree of excess cash shrunk considerably in 2022.

With certain operations undertaken by the RBI in early 2020 set to mature in the next couple of months, the surplus liquidity in the banking system is likely to whittle down to around the neutral zone in coming months, analysts said, with some even warning of a durable deficit setting in.

Liquidity is seen tightening in coming days due to the scheduled redemptions of large-scale long-term repo operations (LTRO) and targeted long-term repo operations (TLTRO). The RBI had broadly conducted these repo operations in early 2020 in order to provide easy access to liquidity and foster financial market confidence at the height of the Covid crisis in India.

According to RBI data, LTROs worth Rs 499 crore are set to mature on February 16. The maturities in the next two months are much larger, with LTROs and TLTROs worth Rs 13,018 crore set to be redeemed in March and that worth Rs 61,131 crore set to mature in April. The total amount of LTROs and TLTROs that will mature till the end of April stand at Rs 74,648 crore, the RBI data showed.

When one takes into account corporate advance tax payments scheduled towards the end of the financial year in March, the liquidity strain on the banking system increases.  

Following liquidity absorptions in the first week of the current month, the RBI has been injecting funds into the banking system for the last seven days, central bank data showed. Over the past seven days, the RBI has injected a daily average of Rs 26,813 crore, implying that banks have been borrowing funds through the central bank’s Liquidity Adjustment Facility.

“The deficit right now is partially owing to the excise tax collections, which is around Rs 40,000-45,000 crore that goes out. I see the RBI continuing with variable rate repo (VRR) operations in a fine-tuned way – they will probably use the 14-day, seven-day and 28-day VRR operations in a calibrated manner. Going ahead, it depends on several factors, including the degree of FX interventions that might be required,” Saugata Bhattacharya, chief economist, Axis Bank said.

During December-January, the daily average absorption of funds by the RBI was at Rs 1.6 trillion, the central bank said earlier this month. This is much lower than a surplus of around Rs 7 trillion in April 2022. Going forward, the extra cash with banks is set to structurally reduce, heralding a liquidity landscape not seen for years.

“Occasionally there will be episodes of deficit whenever there are advance tax outflows and GST outflows, particularly in the middle of March. On a sustained basis, however, liquidity could be in deficit in April because a large chunk will leave the system through the LTRO redemptions,” Soumyajit Niyogi, director, India Ratings said.

Reflecting tighter liquidity, cutoff yields on government Treasury Bills have jumped 15-18 basis points this month, with the 364-day T-bill rate now at 7.16 per cent. The government’s T-bills are the benchmarks for pricing various short-term credit products in the economy. For banks, the drying up of the surplus liquidity exerts more pressure to raise deposit rates to garner funds and finance strong credit demand.

While the liquidity surplus is seen shrinking, analysts pointed to factors such as government spending and signs of a reduced need for RBI interventions in the foreign exchange market as balancing out the outflows.

“I don’t think that we will see a move into deficit for liquidity on a sustainable basis for at least for the next six months or so. I think there’s going to be perhaps some support from government spending going up. Government cash balances are high right now. Also, you will see perhaps some stability in the rupee and the need to do forex intervention (which drains out liquidity) will be contained to some extent,” said Sakshi Gupta, principal economist, HDFC Bank.

“The RBI will do variable rate repos, etc. to keep it broadly in a marginal surplus and prevent a sustained deficit,” she said. As on January 27, 2023, the government’s cash balance was at Rs 2.5 trillion, Gupta said.

According to Bank of Baroda’s chief economist Madan Sabnavis, a key aspect that would shape the liquidity scenario would be the pace of bank credit growth and the overall balance sheet of the banking system.

While growth in credit has far outstripped that in deposits for most of 2022, he said the situation could change in coming months. With economic growth set to slow as a result of a weak global environment and monetary tightening by the RBI, credit growth could lose some momentum while deposit growth could remain firm.

“The major source of revenue is deposits and the major deployment is credit. So, we may not face a situation where there may be a sustainable deficit of liquidity but we’ll definitely not be having the kind of comfortable situation that existed earlier. Moreover, in April, typically credit and deposits don’t grow that much. There’s a sharp fall in credit in the month of April due to seasonal factors,” he said.

TAKING STOCK

• Rs 499 crore worth LTROs set to mature on February 16 
• Rs 74,648 crore worth of LTROs, TLTROs set to be redeemed by the end of April 
• Rs 26,813 crore daily average injection in the system by RBI over the past seven days 
• Rs 1.6 trillion daily average absorption of funds by RBI between December and January 
• This is much lower than a surplus of around Rs 7 trillion in April 2022