Sharp improvement in liquidity expected from January 2024: India Ratings

Govt spending, FPI flows to drive liquidity

The liquidity conditions in the Indian banking system are expected to see substantial improvement from January 2024, owing to a surge in government spending ahead of the vote on account and Foreign Portfolio Investment (FPI) flows in equity markets. The liquidity surplus could touch up to Rs 50,000 crore, according to India Ratings estimates.

Soumyajit Niyogi, Director, India Ratings, said the foreign portfolio investment (FPI) flows in the equity market have surged in December. The lumpy government spending and improvement in the balance of payment account will cause a sharp improvement in banking system liquidity.

The meaningful improvement in the system liquidity would soften yields on Commercial Paper (CPs) and Certificates of Deposit (CDs) from the current elevated levels. However, sustenance of money market yields will depend on the Reserve Bank of India’s (RBI) decision of timing and choice of Open Market Operations (OMO) sells, according to Niyogi.

The number of issuances in the primary commercial paper (CP) market increased in November 2023 in terms of both value and number of issuers, largely driven by the need for higher balance sheet liquidity throughout the year.

The tighter system liquidity and regulatory credit policy pushed short-term rates up. The banking system liquidity remained in deficit in November 2023, as expected. The moderate government spending and festivals led cash in circulation caused severe tightness in liquidity in the month.

The tight liquidity coupled with the Reserve Bank of India’s measures for unsecured lending pushed the short-term rates higher. Non-Banking Financial Companies' (NBFCs) yield for short-term CPs (45 to 90 days) increased 15-25 basis points (bps) month-on-month (MoM). CP yield increased 25 bps MoM for short-term (45 to 90 days) issuances, but it fell 30bp MoM for long-term (180-270 days) issuances in November 2023, the rating agency added.