Ex-banking liquidity skews RBIs fight

Liquidity outside the banking system remains positive even as its negative inside. So the Reserve Bank of India (RBI) will have to reassess its bond purchase programmes and cash reserve ratio (CRR) cuts those are not remedies for temporary maladies. So the one wish for 2013 at Mint Road will be the right tools to tame the beast.

Liquidity has been an issue all through this year with banks borrowing around Rs.140,000 crore on an average daily from the RBI. There was a big bump-up in April, when banks were borrowing Rs90,000 crore, despite the RBI pumping in Rs144,000 crore through bond purchases and CRR cuts. Yet this hasnt mitigated the situation.

Which brings us to the question, how is liquidity in the banking system determined?

By domestic and external factors. But on both fronts, there are no signs of alarm, which complicates the conundrum. One reason, of course, is the cash the government is keeping with the RBI ”Rs90,000 crore at last count. This is largely temporary in nature and will come back into the system on spending by the government.

Then theres hard currency leakage all of Rs.70,000 crore between April and December. This money hasnt returned and is therefore a permanent drain on banking system liquidity.

But the tightness is not reflected in mutual fund assets, which have seen good inflows of Rs.160,000 crores this year. Ideally, because of fungibility, this should have a positive impact on banking system liquidity.

Another factor is growth in loans outstripping deposit growth. The Incremental credit Deposit Ratio of banks is at 79%, having surged from 20% in the early part of this fiscal. Another drain in liquidity, but not alarming yet.

Foreign investors have been heavy buyers, investing over $18 billion in April-December. FII inflows are liquidity-positive and this should be reflected in banking system liquidity.

Trade deficits are outflow of dollars, a liquidity negative. Indias trade deficit for April-November is $129 billion. But this is not reflected in a draw down in Indias foreign exchange reserves, for they have been steady at around $295 billion this fiscal.

Trade deficit is negated by portfolio flows, receipts from invisibles, external commercial borrowings and foreign direct investments reasons why reserves are stable. Net-net, liquidity has not been majorly impacted on the external front.

The RBI has sold $14 billion in the spot and forward currency market and this has had a negative impact on liquidity. However the forward contracts have not matured yet and are not a reason fora liquidity drain.

So what are the solutions?

For one, infusing liquidity without having to buy gilts. Allow banks to borrow overnight money from the RBI to the extent of excess cash levels with the government. Banks can be allowed to dip into their statutory liquidity ratio (SLR) for such purposes. Of course, there are many issues to be sorted out in such temporary measures but it still beats backdoor deficit financing by a wide margin.


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