MPC Minutes: Liquidity overhang pose direct threat to inflation aim, financial stability, says DG Patra

Michael Patra

The Reserve Bank of India (RBI) Deputy Governor Michael Debabrata Patra said liquidity overhang in the banking system pose a direct threat to the inflation target and financial stability, according to the minutes of the Monetary Policy Committee's latest meeting released on August 24.

“Withdrawal of excess liquidity should engage primacy in the attention of the RBI going forward as it presents a direct threat to the RBI/MPC resolve to align India’s inflation with the target, besides the potential risks to financial stability,” Patra said.

Patra further said the central bank should focus on the withdrawal of access liquidity from the banking system.

In the last few months, especially after the withdrawal of Rs 2000 banknotes from the circulation by the central bank, liquidity in the banking system started increasing.

This is because deposits and exchange of these notes. The central bank on May 19, announced the withdrawal of Rs 2,000 currency bills from circulation.

"In view of the above, and in pursuance of the 'Clean Note Policy' of the Reserve Bank of India, it has been decided to withdraw the Rs 2,000 denomination banknotes from circulation," the RBI said on May 19.

While, on May 24, the RBI Governor said the central bank decided to withdraw the Rs 2,000 currency notes as this denomination was not much in use and high-denomination notes could lead to collateral issues.

“In our surveys, we found out that Rs 2,000 notes were not being used at all... It was being used, but not commonly used,” he said.

Since then, the RBI has conducted various variable rate reverse repo auction to withdraw excess liquidity from the banking system. But liquidity still remained in huge surplus.

After this, in August monetary policy, the central bank introduced Incremental Cash Reserve Ratio (I-CRR) with an aim to manage the excess surplus liquidity in the economy.

The central bank said that with effect from the fortnight beginning August 12, scheduled banks will have to maintain an I-CRR of 10 percent of the increase in their net demand and time liabilities (NDTL) between May 19 and July 28.

This move by the central bank along with outflows on account of goods and services tax, tightened liquidity conditions in the banking system and it fell in to deficit for the first time since start of this financial year.

Currently, liquidity in the banking system is estimated to be surplus of around over Rs 20,000 crore.

Meanwhile, India's Consumer Price Index (CPI) inflation print shot up to a 15-month high of 7.44 percent, spurred on by a massive increase in vegetable prices.

At 7.44 percent, the Consumer Price Index (CPI) inflation print for July was a huge 257 basis points (Bps) higher than the revised June number of 4.87 percent and is the 46th month in a row that it has come in above the RBI's medium-term target of 4 percent. One basis point is one-hundredth of a percentage point.

In August monetary policy, the central bank made an upward revision to its inflation forecast for 2023-24, raising it by 30 bps to 5.4 percent.