Tax outflows push banking system liquidity deficit to highest in over 7.5 years

Further, Gaura Sengupta, economist at IDFC First Bank, said the sharp rise in system liquidity deficit reflects a confluence of factors: a rise in currency leakage since the festival season, the RBI’s foreign exchange operations with Balance of Payments (BoP) turning mildly to a deficit since Q2 FY24, and strong tax collections.

Usually, during the quarter-end, there is always pressure on liquidity in the banking system, experts said. This is due to huge outflows of GST worth around Rs 1.5 lakh crore and advance tax payments of around Rs 1 lakh crore, experts added.

On the core liquidity front, Gupta said it would reduce to Rs 0.2 lakh crore by March 2024 from a surplus of Rs 2.1 lakh crore as of December 15, 2023. This is led by a rise in currency leakage, assuming a neutral BoP.

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RBI support

To combat this huge deficit in liquidity, the central bank conducted a variable rate repo auction worth Rs 1.75 lakh crore on December 22. Against this notified amount, banks have put in bids worth Rs 4.26 lakh crore. The central bank accepted bids worth Rs 1,75,013 crore at a cut-off of 6.68 percent and a weighted average rate of 6.70 percent.

Even after this, the liquidity in the banking system remained in a huge deficit.

The impact of the repo auction was not seen due to the reversal of Rs 1 lakh crore from the banking system towards variable rate repo operations conducted by the central bank on December 15, which was scheduled to reverse on December 22, money market experts said.

Impact on overnight rates

The tight liquidity conditions in the banking system have kept overnight call money rates above the Marginal Standing Facility (MSF) rates of the RBI.

Usually, when the liquidity deficit is at its peak, the inter-bank call rates rule above the MSF rate, while in a neutral situation, they are aligned to the repo rate, explains V Ramachandra Reddy, DGM - Head Treasury, Karur Vysya Bank.

“The tight liquidity conditions have kept the weighted average call rate closer to MSF over the last couple of months,” Gupta said.

Currently, the weighted average call money rate is trading at 6.8347 percent.

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Outlook

Experts are of the view that liquidity conditions in the banking system will improve in the coming days due to month-end spending by the government towards salaries and pensions.

Further, Reddy said the RBI is likely to tweak the liquidity position to neutral once inflation moves decisively towards the RBI target of 4 percent and/or the exacerbation of a global slowdown.

“Going forward, the system liquidity deficit is likely to increase in the near term but remain more comfortable in Q1 FY24 as government spending (including election-related) is expected to rise in the coming months,” Arora added.