Mumbai: Liquidity tightness in the Indian banking system is likely to persist in the financial year ending March 2011, driven by rising demand for loans as compared with deposit growth, Goldman Sachs said in a note.
Such a situation may also suit the central bank, given the high inflation and its tightening bias, as its rate hikes can be transmitted more effectively across the economy, they added.
“Our analysis of trends in the components of broad money (M3) suggests that liquidity will remain tight in FY11,” Goldman Sachs economists Tushar Poddar and Pranjul Bhandari wrote.
“Interest rate hikes tend to be more effective when liquidity is tighter, so we think the Reserve Bank of India would prefer the policy rate to be the repo rate,” they added.
Cash with bank dwindled considerably last month when telecom spectrum auction drained more than 1 trillion rupees from banks.
While many bankers still consider the current cash crunch as a temporary measure the higher growth of credit, compared with deposits, may sustain the tightness, Goldman said.
“Underlying our view of liquidity tightness is the economic outlook that domestic demand will remain strong compared to external demand,” according to the note.
This would mean that the overnight rate, which typically hovers around the reverse repo rate, may hug the repo rate for some more time to come, they added.
Goldman Sachs also wrote that tighter cash levels would be desirable for the central bank given high rates of inflation and the tightening bias in the policy.
“The RBI could have loosened liquidity more aggressively through open market operations, statutory liquidity ratio cuts or cash reserve ratio cuts. But they have not done so thus showing a preference for the repo rate,” Poddar and Bhandari said.