Liquidity turns surplus as demand for cash drops post festive season

During the first three days of the month, the Reserve Bank of India (RBI) absorbed a daily average of Rs 71,090 crore from the banking system.

This compares with a daily average injection of Rs 58,213.98 crore between October 20 and October 31, 2022, when the liquidity situation tightened on account of higher demand for cash during the festival season, GST and other tax related outflows and the Reserve Bank’s intervention in the foreign exchange market to contain volatility in the rupee.

Liquidity in the banking system refers to readily available cash that banks need to meet short-term business and financial needs.

“Compared to what we were seeing in October, that (liquidity) tightness was expected to kind of abate in November because the high currency demand during the festive season would have gone and also with the expectation that the government spending will increase and that will improve the liquidity situation,” Care Ratings chief economist Rajani Sinha.

While on November 1, the absorption of surplus liquidity was to the tune of Rs 26,140.89 crore, the central bank absorbed Rs 93,163.62 crore and Rs 93,965.62 crore on November 2 and November 3, respectively.

“There must be some lumpy spending by the government and that is what is getting reflected here,” said Soumyajit Niyogi, director, core analytical group, India Ratings and Research.  Last week, Reserve Bank of India Governor Shaktikanta Das said that the liquidity strain seen in October was likely to be transitory on account of several factors.

“First, the leakage due to currency demand will slow down after the festival season; and as currency returns to the banking system, the system liquidity will improve. Second, government expenditure is likely to pick up after the monsoon season. Third, the pace of forex outflows has moderated, which augurs well for system liquidity, going ahead,” Das had said at a banking event.

The flows from foreign portfolio investors (FPI) also resumed in October after being negative in September. Das had said that deposit growth of banks has picked up in recent fortnights and is working towards bridging the funding gap associated with double-digit credit offtake.

The Governor said the interaction of global and domestic developments somewhat tightened the liquidity conditions in October and the average daily absorption under the liquidity adjustment facility (LAF) amounted to Rs 1.35 lakh crore during the month, down from the average daily absorption of Rs 2 lakh crore in September this year.

Analysts feel that, unlike

last year, the liquidity in the banking system is not going to be in extreme surplus as it will defeat the RBI’s purpose of taming inflation.

“Overall the expectation is that the RBI will not allow that kind of surplus liquidity to be in the system because that doesn’t serve their purpose when they are hiking rates. It (rate hike) will be more effective when the liquidity in the system is not abundant,” Care Ratings’ Sinha said.

Despite raising the repo rate by 190 basis points (bps) since May this year, the RBI has not been able to maintain its inflation target of 2-6 per cent for three consecutive quarters. The consumer price-based inflation (CPI), or retail inflation, has been above 6 per cent — the upper band of its legally mandated CPI inflation target — for nine months, starting January 2022.

Last week, a special meeting of the Monetary Policy Committee (MPC) was convened to discuss and draft a report that the RBI has to send to the government, explaining the reasons for the failure in meeting the inflation target.