Yields on Treasury bills or T-bills spiked on September 21 owing to tighter liquidity conditions in the banking system.
T-bills are short-term debt instruments issued by the government. They are presently issued in three tenors—91 days, 182 days and 364 days. The government typically auctions T-bills every Wednesday.
At an auction on September 21, the Reserve Bank of India (RBI) sold the 91-day T-bill at 5.88 percent yield, up 16 basis points (bps) from the previous week’s 5.72 percent. The cut-off for the 182-day and 364-day papers also jumped 24 bps and 22 bps, respectively from last week’s levels and stood at 6.43 percent and 6.65 percent. One bps equals one hundredth of a percentage point.
The jump in yields was largely attributed to banking system liquidity turning into deficit mode on September 19 amid hefty tax outflows, slower deposit growth and the RBI’s measures to keep the rupee’s depreciation in check against the dollar, according to money market participants.
Consequently, the weighted average rate in the interbank call market for overnight loans rose to as high as 5.72 percent on September 21. The prevalent liquidity condition in the banking system and the monetary policy influence the call money rate.
The RBI, through the monetary policy framework, aims to set the repo rate based on an assessment of the current and evolving macroeconomic situation, and modulation of liquidity conditions to align the operating target of the weighted average call money rate at or around the repo rate. The repo rate currently stands at 5.40 percent.
Why did liquidity turn into a deficit?
The principal factors that led to the negative liquidity in the system are the disparity between credit growth and deposit growth at banks in the last few months, the RBI’s aggressive measures to arrest the rupee’s fall against the dollar and the goods and service tax outflows, said analysts.
“For the last few months, credit growth has been running above deposit growth. In the banking sector, deposit growth was higher than credit growth previously and it helped in building up of liquidity in the system,” said Krishnan Sitaraman, senior director and deputy chief ratings officer, CRISIL Ratings.
Banks have mostly preferred to keep the deposit rate low as it might affect their profitability. On the other hand, with every repo rate hike announced by the RBI, the banks have increased lending rates.
“In the last two quarters, the repo rate has gone up by 140 bps but the deposit rate increase has been much lower. Banks were not too keen to increase the deposit rates as it would have impacted profitability,” said Sitaraman.
Annualised credit growth of commercial banks was at a near nine-year high of 15.5 percent for the week ended August 26, according to RBI data. The next highest print was in November 2013, when it was 16.1 percent.
Retail deposits and bulk deposits grew by 2.5 percent and 15 percent, respectively, from May, after the central bank raised its key repo rate for the first time in 2022, while credit growth outpaced that by a wide margin, growing at more than 15 percent year-on-year.
Moreover, advance tax payment coupled with the GST payments affected liquidity too, said analysts.
“It (deficit) is largely driven by the balance of payments deficit that includes both capital account as well as the current account. The capital account and current account deficit has gone up substantially and it has led to such a liquidity situation,” said Soumyajit Niyogi, director, India Ratings.
In July 2022, the RBI doubled the limit under the automatic route for external commercial borrowings from $750 million per financial year to $1.5 billion in a bid to encourage companies to raise money through this route, which also contributed to the liquidity crunch.
Faster deposit mobilisation
RBI governor Shaktikanta Das mentioned in one of his recent interviews that the banks will increase deposit rates as per the rate hikes and the rate will go up soon. So far, lending rates have risen with every increase of the repo rate, while that has not been the case for deposit rates.
“Reducing liquidity surpluses will drive up the cost of borrowed funds for the banking system and banks will have to aggressively chase deposits by offering higher deposit rates to fund credit growth,” said Anil Gupta, vice president and co-group head, financial sector ratings, ICRA.
As pointed out by analysts, banks for the last few quarters have been disbursing loans by borrowing from the certificates of deposit or the CD market, but this is not a sustainable solution.
To maintain liquidity in the system while also supporting higher credit growth, banks need to ensure that growth in deposits also picks up.
Banks also need to mobilise wholesale deposits to ensure that liquidity is maintained.
“There are banks that are perennially liquidity surplus and there are banks that are perennially liquidity deficit. In this situation, those in deficit need to give out deposit rates at a much higher rate than the market level. This will push the deposit rates in the banking system,” added Niyogi.
The central bank is likely to ensure that the liquidity deficit is addressed in the upcoming policy meet on September 30, said money market participants. The RBI has already announced a repo auction worth Rs 50,000 crore on September 22. The central bank adds liquidity in the system via repo auctions and sucks it out using reverse repos.Das told the media after the monetary policy committee meeting in August, “We have also said that there will be two-way fine-tuning operations with regard to liquidity based on the evolving situation to ensure that there is adequate liquidity in the system.”