BackAs liquidity headache intensifies, RBI needs to calibrate its dosage deftly
Bridging liquidity gap—bank loans vs bank deposits—is necessary as it would work against RBI’s intention to soften interest ratesRBI is trying to fill the deficit through all possible liquidity tools, even adding a new one by doing a forex swap auction
PremiumThe month of March is characteristic of tight liquidity and hardening money market rates. But bankers fear the prevailing deficit has more to it than just a seasonal event, and these fears aren’t unfounded.
Data on bank borrowings from the Reserve Bank of India (RBI) shows that the liquidity deficit has remained high. Although overnight repo operations show banks are net lenders to RBI, term repos show huge borrowings. At last count, banks had lent a little over ₹80,000 crore to the central bank through overnight repos. But they also had an outstanding borrowing of ₹1.5 trillion through various term repos.
Banks are giving out more loans than they are getting deposits; Indians are withdrawing more cash as the nation goes to polls within a fortnight; and the government has tightened its purse strings at the fiscal year-end to meet its target.
The result is a growing deficit of funds within the banking system, which RBI is trying to fill through all possible tools. It even added a new one by doing a forex swap auction earlier this week, which released rupee liquidity of ₹34,561 crore.
Bridging the liquidity gap is necessary as it would work against RBI’s intention to soften interest rates. To be sure, liquidity tightness is exacerbated due to seasonal factors as well as the moving out of cash ahead of elections. These are likely to smoothen out over the next three months.
What should worry RBI is the wedge between deposit and loan growth. As this column pointed out earlier, lacklustre deposit growth would prevent effective transmission of policy rate cuts.
Meanwhile, there is no question that the central bank needs to keep infusing liquidity if it wants its benign policy to reflect in market rates. After a rate cut in the previous policy, RBI cannot afford to allow market rates or even bank lending rates to rise. What good is bringing down the price of money if its availability itself is a question?
Bank of America Merrill Lynch believes RBI should not stop its bond purchases. “Our liquidity model estimates that deposit growth will pick up to 13% from 9.7% now if the RBI injects $35 billion via (open market operations) OMO/forex purchases/CRR (cash reserve ratio) cuts in FY20," the bank said in a recent note. Deposit growth is essentially driven by reserve money/durable liquidity injected by RBI, it added.
But to expect the central bank to do the heavy lifting has its pitfalls too, especially the part where it ends up owning the vast majority of bonds issued by the government. As such, RBI’s liquidity management needs a deft touch, even as it uses all of the tools in its arsenal to make liquidity neutral in line with its policy stance.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
