Liquidity deficit narrows sharply in the new year

Liquidity deficit narrows sharply in the new year

The liquidity deficit in the banking system reduced sharply between December 27 and January 3, 2024, thanks to month-end government expenditures such as payment of salaries and pensions.

Per the Reserve Bank of India’s (RBI) data, the liquidity deficit was reduced by over Rs 1.43 lakh crore, as it fell from Rs 2.62 lakh crore on December 27, to Rs 1.19 lakh crore on January 3.

“The liquidity deficit declined due to government expenditure, which usually starts from the last day of the previous month, and extends into the first week of the next month,” said Gaura Sengupta, Economist, IDFC First Bank.

Swati Arora, Senior Economist, at HDFC Bank said the liquidity deficit was also reduced due to FII (foreign institutional investor) inflows in debt and equity.

Also read: FPIs pour Rs 68,663 cr in debt instruments in 2023, turn positive after 3 years

Tight liquidity in December 

Usually, during the end of the quarter, there is always pressure on liquidity due to heavy outflows on account of payment of advance tax, and goods and service tax (GST).

In December, there was a huge liquidity deficit due to GST payments of around Rs 1.5 lakh crore, and advance tax payments of around Rs 1 lakh crore, according to experts.

GST outflows are a monthly phenomenon, which takes place on the 20th of every month, and advance tax outflows happen during the 15th of the quarter-end month, the experts added.

To support liquidity, the RBI has conducted four variable rate repo (VRR) auctions, but that, too, did not help. In all these auctions, the central bank received bids three to four times higher than the notified amount.

Gupta said the VRR reduces the cost of liquidity,  not the liquidity deficit per se.

“The VRR reduced the cost of funds by providing liquidity marginally below the MSF (marginal standing facility) rate. If the VRRs weren’t conducted, the weighted average call money rate would have been even higher,” Gupta said.

Because of the high deficit liquidity, the overnight call money rate has remained higher than the repo rate, and around the MSF rate. Currently, the overnight call money rate stands at 6.7795 percent, which is above the MSF rate. The MSF is meant for emergency funds when liquidity dries up.

RBI stance

Experts said that the RBI is keeping liquidity in deficit as it is helping them support the transmission of rates and manage overnight rates.

“Tight liquidity keeps overnight rates near the MSF, so using liquidity, RBI has effectively delivered another rate hike. Tight liquidity conditions will support further transmission of past rate hikes done by the RBI,” Gupta explained.

In December 2023, the RBI said that monetary policy must continue to be actively disinflationary to ensure fuller transmission and anchoring of inflation expectations. Different segments of the financial markets have witnessed monetary transmission to varying degrees, the RBI said.

“In the credit market, monetary policy transmission is still working its way through the system,” the RBI had added.

From May 2022 to October 2023, the weighted average lending rate (WALR) on fresh rupee loans increased by 199 basis points (bps), including an increase of 18 bps since April 2023.

One basis point is one-hundredth of a percentage point.

Similarly, the WALR on outstanding rupee loans increased by 112 bps from May 2022 to October 2023, RBI’s December bulletin said.

The bulletin added that the pass-through of WALR on fresh rupee loans and of the WADTDR (weighted average domestic term deposit rate) on fresh deposits was higher for public sector banks than for private banks, while the transmission of WALR on outstanding loans was higher for private banks.

Adding to this, Rajeev Pawar, Head of Treasury, at Ujjivan Small Finance Bank, said that the RBI has been keeping liquidity tight for a year now to control inflation.

Also read: SBI not worried about unsecured loans, says Dinesh Khara

Outlook

Money market experts are divided over the liquidity conditions in the January-March quarter. Some believe that liquidity conditions are likely to improve due to the government’s pre-budget spending.

“Liquidity conditions are likely to improve in Q4 FY23-24 supported by higher budget-related government spending,” Arora said.

However, Gupta expects liquidity conditions to remain tight till February-end, due to a seasonal uptick in currency leakage.