Liquidity situation recovers as govt starts spending

Since December last year, the system was under pressure as the govt did not infuse the advanced tax money into the system

The government has started spending its cash with the Reserve Bank of India (RBI), leading to a sharp improvement in liquidity and a claw-back of short-term rates.

The government’s surplus cash balance, meant for auction with RBI, was at Rs 47,504 crore on April 11, down from about Rs 1.57 lakh crore on March 23, when banks were borrowing close to Rs 2 lakh crore from the central bank to manage their liquidity needs. Banks’ borrowings from RBI have now settled at a little higher than the Rs 1 lakh crore mark. The central banks has not disclosed the actual cash balance. But it was estimated that RBI has a buffer of Rs 20,000-30,000 crore and auctioned off the rest.

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Responding to the liquidity flow, the three-month commercial papers closed at 7.98 per cent on Tuesday, from 8.78 per cent on March 22. The overnight call money rate opened at 6.35 per cent on Tuesday, below the policy repo rate of 6.50 per cent. It closed at 6.52 per cent.

While the system liquidity does improve in April, as the government starts spending its cash kept with RBI around this time, but this time around, the government prolonged the cash holding. Since December last year, the system riled under pressure as the government would not infuse the advanced tax money into the system. The provocation for that was meeting the fiscal target math and any asset accumulated helped.

But the cash holding, in turn, acted as a catalyst for an important policy change in the form of the new liquidity framework. Under the new regime, the central bank will maintain the banking system liquidity in a neutral zone, infusing or sucking out liquidity as need be.

In response to the liquidity shortage though, the central bank bought back more than Rs 60,000 crore of bonds from the secondary market. This was a permanent liquidity infusion, which potentially can make the system liquidity go in a surplus mode if the central bank does not introduce liquidity draining mechanism.

For now though, the currency in circulation remains high for various reasons, including a possible need of cash for elections in states.

“The liquidity situation has improved considerably due to government spending, and it will improve further around May-June as the government start spending more,” said Upasna Bharadwaj, economist at Kotak Mahindra Bank. “In any case, liquidity will remain comfortable in the system as the Reserve Bank will continue to supply more longer-term liquidity through OMOs (open market operations).”