The country’s banking system slipped into the deficit territory for the first time in three years in the second half of the financial year, according to the data of the Reserve Bank of India (RBI).
This widening liquidity deficit could lead to a rise in short-term lending rates and force the Reserve Bank of India (RBI) to inject money into the banking system through repo auctions and slow down its interference in the money market.
"The onset of the festive season and expectations of a gradual recovery in economic growth will boost demand for cash transactions," said Vivek Kumar, an economist at QuantEco Research.
Till last Tuesday, the calculated deficit stood at 218 billion rupees, the highest since May 2019, with tax outflows in the past week also straining the liquidity fund.
“This combination of slowing government spending and increasing tax collection is reflected in the government cash balance,” said Gaura Sen Gupta, an economist with IDFC First Bank.
The financial year (2022-2023) began in early April with a liquidity of over 08 trillion rupees. The withdrawal of liquidity will be a "multi-year" process, the RBI said at the time.
According to Kumar of QuantEco, the core systemic liquidity surplus, which includes the government's cash balance, peaked at 12 trillion rupees in September 2021 but has since declined sharply to 03.9 trillion rupees.
He estimated that more than half of this fall is due to the sale of dollars by the RBI to offset the depreciation of the rupee.
A negative balance of transactions has affected the overall liquidity.
Between January and July, the RBI netted around $39 billion from its forex reserves, falling to a two-year low of $551 billion as of September 09, the data showed.
The U-turn in liquidity has pushed the inter-bank rate above the policy repo rate of 05.4% overnight.
“In the past, the RBI has announced term repo auctions to ease liquidity pressures when the weighted average call rate has exceeded the repo rate for a few days,” said Sen Gupta of IDFC First Bank.
From October 2021 last year, the RBI has stopped receiving any government bonds and analysts do not expect the central bank to come back anytime soon.
QuantEco's Kumar said the central bank may reactivate the fixed and variable rate repo window.
"With monetary policy being put in tight mode, the chances of RBI making OMO (Open Market Operation) bond purchases to increase liquidity are slim," Kumar added.
Following this liquidity position, the RBI on Wednesday announced an overnight variable repo auction (VRR) for 500 billion rupees after the market close.
The central bank will announce the monetary policy on September 30 to infuse cash into the banking system.
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