Liquidity in the banking system rises as govt steps up spending

The increase and decrease in liquidity depends on many factors, but credit growth is not one of them
Liquidity in the banking system has increased by at least Rs 1 trillion since the last week of June as the government has stepped up spending, and the Reserve Bank of India (RBI) has started winding down its outstanding position in the currency forward segment.

Net daily liquidity absorbed from banks on July 9 was Rs 4.6 trillion, data released on Monday showed. Including the outstanding operations, such as long-term repo and standing liquidity facility availed from the RBI, the system liquidity surplus surged to nearly Rs 5.6 trillion. 

The daily net liquidity absorption from banks was about Rs 3.05 trillion in mid-June, which was higher than the near Rs 2.3 trillion at the end of May. However, at the beginning of January banks were parking as much as Rs 7.3 trillion of their excess money with the RBI.

The increase and decrease in liquidity depends on many factors, but credit growth is not one of them.

Liquidity surged because of measures announced by the RBI. Since then, however, the central bank has hiked cash reserve ratio by 50 basis points in two phases and has sucked out nearly Rs 2 trillion of excess liquidity directly from the banking system. Liquidity was pumped in through other forms such as secondary market bond purchases, but those were used by banks to purchase more bonds in auctions, and not for deploying in the reverse repo window of the RBI.

The main reason for the significant fall in liquidity was the central bank’s operations in the currency forwards segment.

At the end of the last financial year, the RBI’s outstanding net forward purchase was around $72.75 billion. This, currency dealers say, has fallen significantly now. In fact, the latest data shows that it fell to $64.94 billion in April.

“The RBI is now a net receiver of premium in the forward market, and that has increased the liquidity pattern again,” said the head of trading at a private bank.

The government has also started spending. How much cash the government maintains with the RBI is known publicly, but analysts estimate it at about Rs 2.5-3 trillion in normal times, but it could have shot up to as much as Rs 4 trillion now. Economists say the government must have started drawing down on the cash balances, and together with the advance tax payment, the government has started spending.

“The advance tax outflows of mid-June has rebounded through government expenditure and has added to banking system’s liquidity,” said Joydeep Sen, advisor, fixed income at Phillip Capital.

Advance tax collections in the first quarter of financial year 2021-22 (FY22) stood at Rs 28,780 crore, registering a growth of about 145 per cent year-on-year. On a gross basis, direct tax collection so far in the current fiscal stands at Rs 2.16 trillion, up from Rs 1.38 trillion in the corresponding period last year.

Some of that money is coming back into the banking system through government spending, experts said.

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