India’s widening bank liquidity deficit calls for additional measures, Reuters traders say

Author: Dharamraj Dhutia

MUMBAI (Reuters) – India’s banking system’s liquidity deficit is set to widen further in the coming quarter, leading to more voices calling for a sustained injection of liquidity.

The banking system’s liquidity shortfall jumped to its highest level in nearly seven months due to tax outflows and the central bank’s regular foreign exchange intervention, market participants said.

CONTEXT

The daily average liquidity of the banking system slipped into deficit in December and increased in the month, despite the central bank reducing the banks’ cash reserve ratio by 50 basis points.

This is the first time that monthly liquidity has slipped into deficit since June, when spending was reduced due to the general election and the formation of a new government.

As of December 23, the liquidity deficit stood at 2.43 trillion rupees.

WHY IT’S IMPORTANT

According to market participants, the excess liquidity of the banking system is a prerequisite for the transmission of lower interest rates to the overall economy.

While the central bank is expected to cut interest rates in February, traders said a rate cut without sufficient liquidity would not be effective mitigation.

GRAPHICAL

KEY QUOTATIONS

“First the rupee should be allowed to move in line with the fundamentals and not drain its reserves and create a further hole in the liquidity situation. Then other steps could come, because you should not be digging a hole and trying to fill it at the same time.

Now that RBI has used the CRR tool once, the next step would be to announce bond purchases in the open market. OMO purchases would support a more flexible and calibrated approach to liquidity injection,” said A Prasanna, head of research at ICICI Securities Primary Dealership.

Kanika Pasricha, chief economic advisor at Union Bank of India (NS:), feels that RBI may consider another cut in CRR. She also said that OMOs and foreign exchange swaps could be other possible measures being used.

“Underlying liquidity fell by about 3.2 trillion rupiah and only 1.2 trillion rupiah was replenished by the CRR cut.”

WHAT’S NEXT

Market participants expect the deficit to widen by about 1 trillion rupees due to a rise in money in circulation in the January-March period, along with other outflows.

So far this year, money in circulation has risen by more than 500 billion rupees, reducing the availability of funds in the banking system.

($1 = 85.3570 Indian Rupees)