By Dharamraj Dhutia

MUMBAI (Reuters)

India’s banking system liquidity deficit is widening, leading to calls for durable liquidity injections. The liquidity shortfall has reached its highest level in nearly seven months due to tax outflows and regular foreign exchange interventions by the central bank.

CONTEXT

Daily average banking system liquidity slipped into deficit in December, which has deepened despite a 50 basis points cut in cash reserve ratio (CRR) by the central bank. This marks the first monthly liquidity deficit since June, influenced by curtailed spending from elections and the formation of the new government. As of December 23, the liquidity deficit stood at 2.43 trillion rupees.

WHY IT MATTERS

A surplus in banking liquidity is essential for transmitting lower interest rates throughout the economy. Although the central bank is anticipated to lower interest rates in February, traders express concern that a rate cut without adequate liquidity will not effectively ease conditions.

KEY QUOTES

> “The first thing should be allowing the rupee to move in line with fundamentals and to not waste your reserves and create a further hole in the liquidity situation. Other steps could follow, but one shouldn’t dig a hole and try to fill it simultaneously.”

A. Prasanna, head of research at ICICI Securities Primary Dealership, noted that after utilizing the CRR tool once, announcing open market bond purchases (OMOs) could support a flexible and calibrated liquidity infusion strategy. Kanika Pasricha, chief economic advisor at Union Bank of India, indicated the RBI might consider another CRR cut, alongside OMOs and foreign exchange swaps.

> “Core liquidity has decreased by around 3.2 trillion rupees, with only 1.2 trillion rupees replenished via the CRR cut.”

WHAT’S NEXT

Market participants predict the deficit could expand by approximately 1 trillion rupees due to increased currency circulation from January to March, in addition to other outflows. So far this year, currency in circulation has increased by over 500 billion rupees, further reducing fund availability in the banking system.

($1 = 85.3570 Indian rupees)