Mumbai: First it was the rising oil price that spooked investors in India’s bond market. Then demand for sovereign debt from state-owned banks dried. Now another pillar of support—liquidity—is giving way.

A seasonal crunch in the banking system is becoming acute because of a buildup in the cash the government parks at the central bank. A lumpiness in revenue—a bulk of it flows into state coffers toward March—and a drop in spending has swollen these balances to between Rs50,000 crore to Rs1 trillion, according to Edelweiss Securities Ltd.

The surplus banks had enjoyed since Prime Minister Narendra Modi’s surprise ban on high-denomination notes in 2016 is also a thing of the past. Excess deposits that lenders left with the central bank have turned into a deficit of Rs33,700 crore as of 27 February, after touching a record Rs5.5 trillion in March 2017, Bloomberg Economics India Banking Liquidity Index shows.

“Liquidity has already reached a stage where the rise in government balances is leading to a deficit in the banking system liquidity," said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. While redemption of market stabilization bonds will add liquidity in mid-March, advance corporate tax outflows will be large enough to widen the deficit, he said.

That’s not good news for a market that’s seen 10-year bonds drop for seven months through February, the longest-losing run according to data compiled by Bloomberg starting in November 1998.

The crunch will impact the rates market unless the RBI adds liquidity aggressively, Rajpal said. Bloomberg

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