Mumbai: India’s central bank may need to infuse cash into the banking system for the second time since January to support credit growth on expectations that tight liquidity may persist above its comfort zone for a sustained period beyond mid-September.
Even though the Reserve Bank of India has maintained that it will keep liquidity in deficit to ensure effective transmission of monetary policy as it fights high inflation, it has also assured banks that it will provide liquidity in order to ensure capital is available to key sectors of the economy.
Dealers expect the RBI to buy around Rs 40000-50000 crore($8.9 billion-$11.1 billion) of gilts, which would ease the liquidity crunch and help limit a sharp rise in government bond yields amid market concerns of higher-than-expected government borrowing in the second half of the current fiscal year.
“We expect RBI to conduct open market operations (OMO) in October because by that time inflation should be easing,” said Manish Wadhawan, director and head of rate trading at HSBC in India.
“Also, an OMO will help to conduct the market borrowing programme smoothly in the second half when the demand for credit puts extra pressure on liquidity,” he said.
In its previous bond purchases from November to January, the RBI bought nearly Rs 67300 crore rupees of bonds via OMO, compared with its target of Rs 84000 crore, helping to contain a rise in yields by up to around 10 basis points despite a hawkish monetary policy tone.
Analysts expect the RBI to conduct a second round of open market purchases of government bonds after mid-September, when they expect advance tax payments and festive season withdrawals to take the liquidity shortfall to more than Rs 1 trillion - above its comfort level of around Rs 60000 crore.
“Given the current low level of excess reserves, if the Reserve Bank of India does not inject reserve money via open market operations, we could see LAF borrowing from banks shoot up much higher from current levels,” said Kumar Rachapudi fixed income strategist at Barclays Capital.
The LAF, or liquidity adjustment facility, is the window through which the RBI borrows and lends on a daily basis.
“Currency in circulation and reserve money deposited by commercial banks will continue to grow in line with trend growth rates, withdrawing liquidity from the banking system,” added Rachapudi.
Last week, RBI deputy governor Subir Gokarn said there was always the possibility of conducting an OMO, based on the liquidity situation.
Analysts said that such a liquidity infusion would not necessarily contradict the RBI’s anti-inflation stance. The RBI wants to curb inflation but not choke off growth.
Unusual cash crunch
The fiscal year started with unusually tight cash conditions due to public withdrawal of currency from banks, high cash reserve ratio requirements for banks and higher-than-expected short-term government borrowing due to a funds mismatch.
While liquidity in the last two fiscal years was positive by around Rs 50000 crore to Rs 70000 crore in the first quarter that begins in April, this fiscal year cash conditions have been negative in a range of Rs 70000 crore to Rs 1 trillion.
New Delhi’s recent cut in customs duty on crude oil and petroleum products may outweigh the gains from an increase in fuel prices and lead to higher government borrowing in the second half of the fiscal year, dealers said.
India raised diesel prices about 9% on Friday after months of delay and also cut customs duty on crude and petrol products and reduced excise duty on diesel, which will result in a total revenue loss to the government of about Rs 49000 crore this year.