Liquidity deficit in banking system to narrow this week on month-end govt spending

Liquidity

Liquidity deficit in the banking system is likely to narrow this week due to expectations of huge month-end government expenditure towards salaries and pensions, money market experts said.

“Liquidity deficit should narrow in coming days due to government spending,” said Ritesh Bhusari, deputy treasury head at South Indian Bank.

Usually, in the last week of every month, the banking system gets some inflows from government spending ranging between Rs 1.5 lakh crore and Rs 2 lakh crore, which helps improve liquidity and lowers short-term rates.

“We expect system liquidity conditions to ease significantly led mainly by month-end government spending. We note that government spending needs to be aggressive through the rest of FY2024 given the expected run down of high cash balances,” said Upasna Bhardwaj, Chief Economist at Kotak Mahindra Bank, in a report.

The Reserve Bank of India (RBI) conducted various variable rate repo auctions to support higher deficit liquidity, but this did not help much. During all the auctions, the bids submitted by banks remained two to three times higher than the notified amount.

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Inflows and outflows

As per the Kotak Mahindra Bank report dated February 26, inflows worth Rs 2.54 lakh crore are expected between February 24 and March 1. On the other hand, outflows of Rs 71,800 crore are expected this week.

Inflows are expected on account of coupons worth Rs 17,000 crore, redemptions of treasury bills worth Rs 28,900 crore and Rs 7,900 crore of state development loans, the report added. There are other inflows of Rs 2 lakh crore of government spending, it said.

On the other hand, treasury bills and state development loan outflows worth Rs 34,000 crore and Rs 32,800 crore, respectively, are expected this week, along with outflows of Rs 5,000 crore for currency in circulation, the report said.

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Impact on short-term rates

Higher deficit liquidity has kept overnight call money rates above the repo rate and close to the Marginal Standing Facility rate (MSF). Sometimes overnight call money rates also remained above the MSF rates due to higher deficit liquidity.

In the coming days, overnight call money rates are expected to remain below MSF rates due to expected inflows in the banking system, experts said. Whenever the tight liquidity conditions in the banking system ease, the demand for funds in the overnight call market reduces leading to a fall in rates.

“My interpretation is that RBI wants to keep the overnight rate near to the repo rate,” Bhusari added.

Currently, the overnight weighted average call money rate is trading at 6.7473 percent.