Liquidity slides into deficit for first time in over 3 years: RBI data

Days of easy money over as credit growth rises

Liquidity in the banking system — as gauged by the Reserve Bank of India’s (RBI’s) daily operations — has slipped into a deficit mode for the first time in over three years, signalling a structural shift away from loose financial conditions in the economy.

According to the RBI’s daily data on money market operations, the central bank infused net liquidity worth Rs 21,873.43 crore into the banking system on September 20 —most since May 2019, money market officials said. This means commercial banks, which were thus far parking their excess funds with the RBI, are now borrowing from it via the marginal standing facility window a rate of 5.65 per cent.

The drying up of liquidity means banks will up the ante in mobilising deposits by further increasing deposit rates. Many banks have started special deposit schemes over the past month, offering 6.1-6.2 per cent interest on fixed deposits. Interest rates on bulk deposits have also risen sharply over the past few months. 

Besides, the festive season will see a rise in discretionary spending, thus impacting system liquidity.

The tight liquidity condition has made itself felt through higher money market rates. The interbank call money rate -- or the rate at which banks lend to each other -- has risen to a three-year high of 5.85 per cent (intraday) in the past couple of days. The weighted average call rate (WACR), which is the operating target of the RBI’s monetary policy, too, has climbed to around 5.50 per cent. Just a couple of months ago, the WACR was around 4.80 per cent, lower than the repo rate.

At the present level, the call rate is well above the repo rate of 5.40 per cent. The cut-off yield on the 364-day Treasury bills issued by the Centre has climbed 51 basis points, so far, in the ongoing quarter. The rise in money market rates has a hardening effect on borrowing costs across the economy.

Further evidence of surplus cash with banks drying up is the fact that the RBI has announced an overnight variable rate repo auction worth Rs 50,000 crore, to be held on September 22. Money market participants said that the current liquidity deficit in the banking system is around Rs 20,000 crore.

Though the current transition to deficit liquidity is transient, which is primarily been driven by large outflows from the banking system on account of advance tax payments, the fact that excess funds have whittled down to such an extent is an event of note.

Liquidity in the banking system was maintained at a surplus for almost four years, with the RBI restarting fund infusions through open market purchases of bonds since December 2018 when the crisis in IL&FS occurred.

The central bank stepped up liquidity infusions through a variety of instruments following the Covid outbreak in India in March 2020, in order to keep financial markets running smoothly through the crisis. At its height, the liquidity surplus -- in the last two years -- was close to Rs 10 trillion.

“The liquidity surplus has been shrinking for nearly a year now. This is happening because of exogenous factors, as well as endogenous factors. Among the endogenous factors are currency in circulation and reserve requirements, which are more systemic and stable,” Vivek Kumar, economist, QuantEco Research, told Business Standard.

“Another factor is the RBI’s policy actions on the forex front. In the current financial year, the activity of the RBI on the FX front has increased significantly and more so in July-September,” he said.

When the RBI sells dollars, it sucks out rupee liquidity from the banking system. In July, the RBI net sold $19 billion in the currency market to protect the rupee from excess volatility amid higher US interest rates.

A sharp pick-up in credit growth has also added to the stress on liquidity. Loans of commercial banks are growing at 15.5 per cent year-on-year, at a 9-year high.

Another key factor influencing liquidity conditions is the government’s spending. While the government has been spending at a fast clip on capex, its revenue expenditure has not kept pace, experts said. The government’s cash balance at the moment is estimated at Rs 3 trillion and that sum is expected to flow into the banking system in October-December.

“On a strategic note, I think the government still has a significant amount of cash surplus. Going forward, we expect, especially in the second half when you traditionally have a busy season, the government to be actually seen spending these amounts,” said Indranil Pan, chief economist, YES Bank.

“At a certain point, we were expecting that we might have a CRR (cash reserve ratio) increase in the fourth quarter when the government spending comes in. Now that liquidity is less than 1.5 per cent of NDTL (net demand and time liabilities), we are no longer talking about a CRR increase. The view is a status quo through the financial year and even in the first quarter of the next,” he said.

According to HDFC Bank’s Principal Economist Sakshi Gupta, even as the RBI is on a monetary tightening cycle, it may not be comfortable with permitting liquidity to slip into a durable deficit in the current fiscal year. She expects more repo operations from the RBI, perhaps even of longer tenures.

“It is a very difficult situation for the RBI to maintain borrowing costs and, at the same time, keep liquidity management in line with the repo rate stance. I think they are trying to and will balance these two objectives,” Gupta said.

“With liquidity coming down because of structural factors or intervention, it, in fact, gives the RBI space to do OMOs if it has to stabilise yields. At the end of the day, the RBI is looking at stabilising the FX and bond markets as much as possible,” she said.

Impact of liquidity tightening

• Banks are borrowing from MSF window at 5.65%
• Overnight call rates are at three-year high
• Increase in fixed deposit rates
• RBI has announced an overnight variable rate repo auction of Rs 50,000 crore, to be held on Sept 22
• T-bill yields rise 51 bps in Jul-Sep, leading to higher borrowing costs