According to the latest edition of State Bank Of India's Ecowrap, surplus domestic liquidity as given by outstanding Net LAF stands at Rs 5276 billion as on 22 Nov, with average surplus being Rs 4150 billion so far in the current fiscal. One factor which is increasing market liquidity is RBI's dollar purchases to prevent further appreciation of Rupee.
The research suggests that in the current environment of liquidity surplus, if the RBI continues its intervention in the market and prevents rupee's appreciation, lower bank loan rates than equivalent rated bonds, can impact banking sector profits and initiate asset liability mismatch.
A higher inflation is also a critical factor. The US dollar is expected to remain weak due to fragile US economic conditions. Overall, merchant dollar supply is far higher than demand. The update states that it would do no harm for RBI to lean with the wind and let rupee appreciate which would reduce imported inflation when metal prices are rising, and clear the liquidity overhang to some extent.
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