Government Spending Drives Banking System To Surplus Liquidity For First Time Since April

Inflows on account of government spending at the end of the month tipped scales towards surplus liquidity in the banking system on Friday, according to data from the Reserve Bank of India.

On May 31, liquidity in the financial system—measured by the amount banks borrowed from the Reserve Bank of India through the repo window—stood at a surplus of Rs 4,000 crore, for the first time since April 19, data showed.

Call money market traders are of the view that around Rs 1 lakh crore of funds, on account of government spending, have come into the system so far, and close to Rs 50,000 crore may hit the market on Monday.

Typically, overall liquidity is impacted by periodic flow in and out of the banking system due to government spending, tax payments, excise duty payments, and more.

While headline liquidity has remained tight over the last several months, the core liquidity surplus is estimated to be at Rs 3.4 lakh crore after the bumper dividend payout by the central bank to the government on May 24, according to Gaura Sengupta, chief economist at IDFC First Bank Ltd.

As of March 29, core liquidity stood at a surplus of Rs 2.3 lakh crore, Sengupta said.

"Liquidity is expected to improve in the second half of FY25 as government spending picks up once the final budget is presented. The government cash surplus is a substantial post-RBI dividend," Sengupta said.

"We also expect the balance of payments surplus to rise in H2 FY25. Capital flows and bond index flows will come through. The Fed rate cut cycle may also start in September, which will improve global sentiment," she said.

Moreover, euphoria about stability in India's economic policies as well as strong GDP data for FY24 has cheered market participants. Exit polls have predicted a win for the incumbent National Democratic Alliance government.

Madhavi Arora, lead economist of Emkay Global Financial Services, expects the net liquidity surplus to average around 0.5-0.8% of net demand and time liabilities in the next three months, versus an average deficit of about 0.5% of the net durable liquidity surplus in most of May.

As of May 17, the net durable liquidity surplus stood at Rs 1.51 lakh crore, RBI data showed.

The RBI has been managing liquidity conditions through a combination of main and fine-tuning repo and reverse repo auctions. On Friday, RBI conducted a 14-day variable rate repo auction for Rs 50,000 crore, which was fully utilised at a cut-off rate of 6.59%. Its reversal will take place on June 14.

Upasna Bhardwaj, chief economist at Kotak Mahindra Bank Ltd., expects the system liquidity deficit to improve marginally, led by inflows from coupon payments, redemptions, and government spending more than offsetting outflows from auctions and indirect tax collections.

"With government spending expected to pick up from Q2 FY24, along with the bond index inclusion-linked inflows, the RBI may remain active in absorbing any excess liquidity in order to keep the overnight rates anchored around the repo rate," Kotak Mahindra Bank economists said in a note.

Since core liquidity remains around Rs 3.6 lakh crore, money markets will remain watchful of cues from the RBI's monetary policy scheduled on Friday for liquidity absorption tools, they said.