Synopsis: In September, the Reserve Bank of India (RBI) injected funds into the banking system, addressing a liquidity deficit caused by quarterly advance tax payments and monthly GST payments. However, liquidity conditions have now shifted to a surplus, driven by government spending and foreign inflows.
In response to liquidity deficits caused by quarterly advance tax payments and monthly GST payments, the Reserve Bank of India (RBI) injected funds into the banking system over a seven-day period in September 2024.
The liquidity crunch was short-lived, as conditions swung back to a surplus by late September, thanks to increased government spending and strong foreign capital inflows.
On September 26, the RBI's absorption of Rs. 44,337.34 crore from banks signalled the presence of excess liquidity in the system.
This action led analysts to speculate that the central bank may be leaning toward a more accommodative stance in its upcoming monetary policy review, scheduled for October 9.
The RBI's willingness to allow surplus liquidity to prevail for several months indicates a shift in its policy, especially compared to 2023, when the central bank aggressively drained excess funds to control inflation.
The recent liquidity surplus has persisted since June 28, with banks parking an average of Rs. 1.3 lakh crore with the RBI on a daily basis.
Liquidity and Its Impact on Markets:
In India's financial markets, surplus liquidity leads to cheaper borrowing costs. For instance, yields on government treasury bills have declined significantly between June and September, with 91-day, 182-day, and 364-day bills falling by 15, 20, and 26 basis points, respectively. These treasury bills serve as key benchmarks for pricing short-term corporate debt.
Experts believe that the RBI’s tolerance for surplus liquidity reflects comfort with the current inflation trajectory. Kotak Mahindra Bank’s chief economist Upasana Bhardwaj suggests that this liquidity surplus, coupled with a gradual easing of inflation pressures, increases the likelihood of a shift in the RBI’s monetary policy stance. However, she notes that risks remain, particularly with the uneven progress of the monsoon season, which could influence the central bank’s decision.
Liquidity and Bank Credit Growth:
Another factor contributing to the RBI’s decision to maintain surplus liquidity may be the persistent gap between bank credit growth and deposit growth, which has been ongoing for the past two years.
As of September 6, 2024, credit growth stood at 14.7%, outpacing deposit growth at 11.6%.
Although this gap has narrowed since 2022, banks continue to explore ways to mobilize funds to meet credit demand.
Gaura Sengupta, chief economist at IDFC First Bank, believes that the RBI’s liquidity management approach over the last few months may also be aimed at supporting deposit growth.
Reserve money growth has slowed from 12.3% year-on-year in FY22 to 6.8% as of September 2024, signalling the central bank’s efforts to align liquidity with broader economic goals.
In conclusion, the RBI’s actions in managing liquidity reflect a possible shift toward a more accommodative monetary policy, with surplus liquidity prevailing in the banking system for several months.
While inflation remains under control, the central bank's tolerance for higher liquidity may also be driven by the need to address the imbalance between credit and deposit growth.
As markets anticipate the October policy statement, the RBI's stance could offer crucial insights into the future of monetary policy in India.
Disclaimer: This article is based on publicly available information and expert opinions. The details provided may change depending on the Reserve Bank of India's policies and economic developments. Readers are advised to follow official updates for the latest information.
