The banking system’s liquidity shortfall has jumped to its highest level in nearly seven months due to tax outflows and central bank’s regular foreign exchange intervention, market participants have said.
So far this year, currency in circulation rose by more than 500 billion rupees, reducing availability of funds in the banking system
India's banking system liquidity deficit is projected to further expand in the next quarter due to tax outflows and the central bank's forex interventions, despite recent measures like the cash reserve ratio cut. Market participants suggest additional durable liquidity injections through open market operations and possible further cuts in the cash reserve ratio.
India’s Banking System Faces Liquidity Deficit: A Synopsis
India’s banking system is bracing for an expanding liquidity deficit in the upcoming quarter, driven by factors such as tax outflows and the Reserve Bank of India’s (RBI) foreign exchange interventions. Despite recent measures, including a 50-basis-point cut in the cash reserve ratio (CRR), the shortfall has reached its highest level in nearly seven months, raising concerns among market participants and policymakers.
Key Drivers of the Liquidity Deficit
Tax Outflows: The end-of-year tax collections have significantly reduced the available liquidity in the banking system.
RBI’s Forex Interventions: Regular interventions in the foreign exchange market to stabilize the rupee have drained liquidity.
Seasonal Factors: December historically sees heightened spending pressures, compounded this year by other systemic outflows.
Currency in Circulation: So far this year, the currency in circulation has increased by more than 500 billion rupees, further reducing the availability of funds in the banking system.
Current Liquidity Trends
Widening Deficit: The daily average banking system liquidity has been in deficit throughout December, a stark shift compared to the previous months.
Deficit Figures: As of December 23, the liquidity shortfall stood at 2.43 trillion rupees, marking the highest level since June 2024.
Expected Widening: Market participants expect the deficit to increase by an additional 1 trillion rupees in the January-March period, primarily due to a rise in currency in circulation and other outflows.
Policy and Market Implications
Market participants are calling for additional measures to address the liquidity crunch:
Durable Liquidity Injections: Suggestions include conducting open market operations (OMOs) to infuse long-term liquidity into the system.
Further CRR Cuts: Economists, including Kanika Pasricha, chief economic advisor at Union Bank of India, have indicated that another reduction in the CRR could provide immediate relief to banks.
Foreign Exchange Swaps: Pasricha also pointed out that forex swaps could be another effective tool for managing liquidity.
Expert Opinions on Liquidity Management
A Prasanna, ICICI Securities: He emphasized the importance of letting the rupee move in line with market fundamentals to avoid depleting reserves unnecessarily. He suggested that the RBI’s next step should be to conduct OMOs for a more flexible and calibrated approach to liquidity infusion.
Kanika Pasricha, Union Bank of India: She noted that core liquidity has declined by 3.2 trillion rupees, of which only 1.2 trillion rupees has been replenished through the CRR cut, leaving significant room for further interventions.
Broader Implications
The liquidity deficit has broader repercussions:
Bank Deposit Rates: These are expected to remain firm as banks compete to attract deposits to manage the shortfall.
Loan Demand: With the peak loan demand season in Q4, maintaining balance sheet health while meeting credit requirements could pose challenges for financial institutions.
Rate Transmission: A surplus in system liquidity is essential for effective transmission of lower interest rates into the broader economy. Market participants have warned that any rate cuts without sufficient liquidity measures may fail to deliver the desired easing effects.
Looking Ahead
The expanding liquidity deficit underscores the importance of proactive measures from the central bank and government. While temporary measures like CRR cuts have offered limited relief, sustained interventions such as OMOs and forex swaps could provide the durable liquidity required to stabilize the system.
Related Topics:
Bank Deposit Rates in Q4: How they’re influenced by peak loan demand.
India’s Economic Outlook 2025: Balancing cautious optimism with fiscal realities.
Government Policies in 2024: Impact of simultaneous polls on economic planning.
