The Reserve Bank of India (RBI) headquarters in New Delhi. (Photographer: Anindito Mukherjee/Bloomberg)

Liquidity Deficit May Spike To Rs 2 Lakh Crore By March-End

The Indian economy is bracing for another bout of tight liquidity over the next two weeks, as a host of factors lead to an outflow of funds from the banking system. Advance tax and GST payments, higher leakage of currency ahead of the election and a gap in credit and deposit growth could lead to a cash crunch and force the central bank to step-in with more liquidity soothing measures, senior economists and market experts told BloombergQuint.

At present, while liquidity is in deficit, the gap is small at about Rs 31,200 crore, as on March 13. This deficit could rise sharply to over Rs 2 lakh crore over the next two weeks. To be sure, a large part of this deficit, created by tax outflows, will likely prove to be transient.

According to market participants, the math could look something like this:

  • About Rs 1.3 lakh crore to Rs 1.5 lakh crore would flow out on account of advance tax payments.
  • Another Rs 90,000 crore would need be paid in the form of GST.
  • These seasonal outflows will come atop a pre-election increase in currency in circulation and a gap between deposit growth and credit growth.

Together, this could mean significant liquidity tightness, say economists.

While liquidity deficit is fairly comfortable as of now, we foresee significant tightness in the coming weeks on account of both durable and frictional factors.
Shubhada Rao, Chief Economist, Yes Bank
Liquidity Deficit May Spike To Rs 2 Lakh Crore By March-End

Beyond Seasonal Factors

Apart from the seasonal tax outflows, higher currency in circulation ahead of the elections is putting pressure on system liquidity.

For the week ended March 8, the latest data available, currency in circulation rose a steep 1.2 percent over the previous week to hit Rs 21.32 lakh crore. The ratio of currency in circulation to GDP is on course to touch 11.2 percent by the end of FY19, said Yes Bank in a report on Thursday.

There could also be some additional currency leakage due to general elections and the new farm income transfer scheme. “The transfer payment from the central government (via PM-Kisan scheme) along with few state governments (various schemes) could also potentially increase the demand for currency in the coming quarters,” Rao said.

Higher currency in circulation is one reason why bank deposit growth has been slower than bank credit growth. Bank credit grew at 14.5 percent for the fortnight ended March 1, while bank deposits rose by 9.8 percent.

“Bank credit growth this year has been higher and has surpassed deposit growth. This has been the key factor constraining liquidity in the banking system in recent months since Oct’19,” said Madan Sabnavis, chief economist at CARE Ratings.

Liquidity Deficit May Spike To Rs 2 Lakh Crore By March-End

RBI’s Liquidity Support Options

The RBI has provided large amounts of liquidity support to the markets through FY19, mostly through bond purchases under its open market operations (OMO) program.

The central bank has bought bonds worth Rs 2.8 lakh crore or nearly 75 percent of the supply of government securities. Given the conditions, the RBI had no option but to actively use OMO bond purchases to ease liquidity, said Soumyajit Niyogi, Associate Director, India Ratings & Research

This has been a year of volatility with rupee under pressure and oil prices going up unexpectedly. The expectation was that there would be large foreign inflows but we actually saw outflows which added pressure on the capital account and current account, which were in deficit for two quarters. 
Soumyajit Niyogi, Associate Director, India Ratings & Research

However, the RBI is now looking at options other than bond purchases to infuse liquidity. This is partly because the excess holding of government bonds with banks has declined due to higher credit demand.

Banks are required to hold a certain amount of government bonds as part of the statutory liquidity ratio and liquidity coverage ratio requirements. In times of weak credit growth, banks hold government securities in excess of the required amount. They sell these down when credit demand picks up.

Niyogi of India Ratings said that a March-end liquidity deficit of upto Rs 1.5 lakh crore can be managed through the RBI’s Liquidity Adjustment Facility, where banks raise funds using government bonds as collateral. “If the deficit goes up significantly above Rs 2 lakh crore there is no harm in continuing these auctions, but banks may not have enough securities to park against their borrowings from RBI,” he said.

Meanwhile, on Wednesday, the RBI said it would infuse upto Rs 35,000 crore through long term forex swaps. The swaps give the central bank another tool with which to infuse liquidity, said Madhavi Arora, economist at Edelweiss Securities.

The forex swap route has been explored by various emerging market central banks as an effective tool to manage liquidity. It is encouraging that RBI intends to rejig its liquidity management framework and look for options beyond the open market operations for durable liquidity addition.
Madhavi Arora, Economist, Edelweiss Securities