RBI steps up fund infusion as system liquidity 'almost neutral'

Rates on CPs, CDs surge; pressure mounts on banks to raise deposits

Increased demand for cash during the festival season, a slow pace of government spending, tax outflows, and the central bank’s interventions in the currency market have led to the overall liquidity surplus in the banking system almost entirely drying up, analysts said.

Over the last five days, the Reserve Bank of India (RBI) has injected a daily average of Rs 72,456 crore worth of funds into the banking system. The cash infusion on October 25 nearly hit the Rs 1-trillion mark, at Rs 98,372.89 crore – the largest since April 24, 2019, when the RBI had infused funds worth Rs 1.45 trillion.

When the RBI injects funds into the banking system, it implies that liquidity conditions are tight.

Over the past few days, outflows on account of goods and services tax (GST) payments have occurred in the banking system, with the dealers pegging the amount at close to Rs 1.5 trillion this week.

“Banking system liquidity is almost neutral at this point due to festival season-related cash demand and still elevated government cash balances,” IFA Global Chief Executive Officer Abhishek Goenka told Business Standard.

In April, the liquidity surplus in the banking system was around Rs 7 trillion.

“The Rs 1-trillion 14-day VRRR (variable rate reverse repo) auction had seen negligible uptake,” Goenka said.

At the RBI’s last 14-day VRRR auction on October 21, the central bank received bids worth only Rs 5,648 crore out of the notified amount of Rs 1 trillion.

The low quantum of bids received by the RBI indicates banks’ reluctance to park funds with the central bank at a time when surplus liquidity has shrunk significantly. In a reverse repo operation, banks deploy excess cash with the RBI.

The tightening liquidity has made its impact felt through higher money market rates. The weighted average interbank call money rate, which is the operating target of the RBI’s monetary policy, has been above 6 per cent for 12 out of the 18 working days in October. This is higher than the prevailing repo rate of 5.90 per cent.

According to the RBI’s monetary policy framework, the operating framework of monetary policy aims at aligning the weighted average call rate (WACR) with the repo rate through proactive liquidity management.

Not only has the WACR been above the repo rate for a large part of the current month, it has been at or above the marginal standing facility (MSF) six times. The MSF – currently at 6.15 per cent – is the upper band of the RBI’s interest rate corridor. When banks borrow funds through the MSF route, they shell out the highest rate of interest to receive funds.

“Within the banking system, there are pockets of surplus and deficit. The overnight call rate has been consistently above the MSF rate. The RBI has been sterilising its FX intervention through buy-sell swaps. It is effectively avoiding sucking out liquidity from the banking system by doing so,” Goenka said.

Higher money market rates have translated into a sharp increase in short-term cost of borrowing for banks and other corporate entities. From September 30 to October 27, rates on three-month PSU certificates of deposits have climbed 60 basis points (bps), while those on three-month commercial papers have jumped 45-57 bps, Bloomberg data showed.

In the current scheme of things, tighter liquidity may be aligned to the RBI’s goals, as the central bank seeks to rein in elevated inflation. Analysts pointed out that the central bank has not offered banks a repo window to borrow funds for more than a month even as liquidity has tightened at an accelerated pace.

The higher market rates also come at a time when aggressive rate hikes by the US have made it important to maintain interest rate differentials and thereby shield the rupee from excessive volatility, analysts said.

With the pace of decline in surplus liquidity picking up, banks face pressure to mobilise deposits amid booming credit growth. As on October 7, bank credit growth was at 17.9 per cent year-on-year, while deposit growth lagged far behind at 9.6 per cent.

“A significant part of the funding gap has been met by the mobilisation of certificates of deposit (CDs). The outstanding CDs stood at Rs 2.26 trillion as of October 7, 2022, as compared to just Rs 0.59 trillion a year ago,” rating firm CareEdge wrote.

“Further, banks are expected to keep their CD issuance elevated to meet their short-term need amid the lower liquidity. Banks would also focus on deposits (bulk as well as retail) to meet the rising credit demand,” the firm wrote.