Liquidity Deficit In Indian Banking System At Record High
Liquidity deficit is a function of government not spending and tax outflows, according to Yes Bank's Indranil Pan.
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India’s banking system liquidity deficit hit a record high on Wednesday due to the advance tax outflow and a slowdown in government spending.
The liquidity deficit in the banking system stood at Rs 3.46 lakh crore on Wednesday, according to the latest data by the Reserve Bank of India. At the beginning of January, the liquidity deficit stood at Rs 1.28 lakh crore.
To plug the shortfall, the RBI has been injecting liquidity through variable-rate repo auctions since December 2023. On a net basis, it has injected liquidity averaging Rs 1.8 lakh crore until Wednesday.
The central bank, to help lower the liquidity deficit, conducted a 15-day variable rate repo auction worth Rs 2.5 lakh crore on Thursday.
"Liquidity deficits, currently is a function of government not spending and tax outflows. To that extent, for each quarter, liquidity tightens a bit," Indranil Pan, chief economist at Yes Bank Ltd., told NDTV Profit. "My view is that the RBI will definitely be taking care of liquidity gaps through VRR auctions."
Limited spending by the government so far could be intended to keep the fiscal deficit number for FY24 below the 5.9% target, Pan said. Therefore, the government will have headroom for increased expenditures before the elections this year.
"They might be conserving their spending because they want to show fiscal consolidation this year...the urge to spend may be lower because you have growth relatively on the higher side," he said. Pan expects some easing in the liquidity deficit in next couple of months as the government steps up its spending as the financial year-end nears.
Analysts at Bernstein Research agree.
With about 40% of total government spending yet to materialise, the near-term liquidity deficit is expected to ease into the next quarter. "A similar ending cash balance as of FY23 could lead to an addition of Rs 3 lakh crore to banking system liquidity, thereby easing some funding constraints and leading to better deposit growth for the banks," Bernstein said in a Jan. 18 note.
The liquidity shortage has resulted in banks scrambling to secure funds for their asset liability management, which has turned them towards the interbank call money market to mobilise funds.
"The short-term money-market rate has inched above the repo rate and closer to the marginal standing facility rate, leading to funding constraints for the banks," the note said.
It is not appropriate to infuse durable liquidity in the banking system at this juncture, given that the government has parked its surplus cash balances with the RBI, said Vivek Kumar, economist at QuantEco Research. In a scenario of increased government spending in the coming quarters, durable measures like a reduction in the cash reserve ratio would send a conflicting signal vis-à-vis the current monetary policy stance.
"What the RBI could do is increase the size of its VRR auctions and introduce various tenors, besides restarting FRR operations," Kumar said.
Banks will have to rely on short-term money market instruments to meet the funding shortfall, as repricing risk is higher for deposits, according to Yes Bank's Pan.
"If a bank raises deposit rates and is able to garner resources at a higher rate, the question is whether there will be appetite for credit at those higher rates," Pan said.
"The main thrust, in terms of credit movement, was through personal loans. Any further increase in risk weightage may not see appetite going forward. To that extent, there may be a slowdown in the economy—much sharper than what was anticipated," he said.
Elevated short-term money market rates—starting from overnight rates to commercial papers—certificates of deposit are not conducive for the financial system as well as economic growth, said India Ratings and Research Pvt.
"Sustained tightness in the banking system's liquidity could prove to be onerous for borrowers and will worsen if government spending does not accelerate in a meaningful way. Therefore, the infusion of durable liquidity is becoming necessary," said Soumyajit Niyogi, director of the core analytical group at the ratings agency.
The monetary policy stance should change to ‘neutral’ from ‘withdrawal of accommodation’, to maintain consistency of stance and action, he said.