As of January 23, the liquidity deficit – measured by the amount banks borrowed from the Reserve Bank of India – was at ₹3.34 lakh crore, the highest ever, Reserve Bank of India data showed. The last time the amount of funds injected by the RBI into the banking system had topped the ₹3 lakh crore mark was in April 2016.
A consequence of the tight liquidity was elevated funding costs for banks as the weighted average call rate – which represents banks’ overnight cost of borrowing – rose to 6.85% on Wednesday, much above the RBI’s repo rate of 6.50% and higher than the Marginal Standing Facility (MSF) rate of 6.75%. The MSF represents the upper end of the central bank’s interest rate corridor, with the repo rate being the middle, and the Standing Deposit Facility the floor.
“In the new liquidity framework, the emphasis is more on the price of money rather than the volume of money. So, 6.85% might be higher than what you would normally think the RBI would be comfortable with. You might see mitigating action from the central bank now,” said Rahul Bajoria, head of emerging markets Asia economics at Barclays.
The high overnight borrowing costs for banks have been passed through to short-term debt instruments such as commercial papers (CP) and certificates of deposit (CD), leading to a rise in borrowing costs for firms too. So far in January rates on three-month CPs issued by non-banking financial companies and manufacturing firms have climbed 35 basis points and 20 basis points, respectively, money market traders said. Meanwhile, rates on three-month CDs issued by banks have risen 25 bps, they said. One basis point is 0.01%.
LIQUIDITY DRIVERS
Overnight market rates are supposed to be contained within the rate corridor, with the RBI’s monetary policy framework saying that it aims to align the weighted average call rate with the repo rate through proactive liquidity management.
The latest trigger for the tight liquidity conditions was the monthly outflow on account of goods and services tax, with bankers estimating the net outflow at ₹1.2 lakh crore.
Bankers said that the previous week had also witnessed an outflow worth around ₹31,000 crore due to a seasonal rise in currency in circulation amid festivals. A large build-up of government cash balances due to a slow pace of government spending has exacerbated the tight liquidity conditions. When the government ramps up expenditures, funds flow through the banking system.
An overarching factor that has exerted pressure on bank liquidity since 2022 is the faster pace of bank credit growth compared to deposit growth, which means funding pressure for banks. Over the past year, the RBI has also taken steps to reduce the large liquidity surplus that existed in the Covid period as excess liquidity poses inflation risks.
The central bank, which is withdrawing monetary accommodation to control inflation, has stressed the need for better transmission of the 250 basis points of rate hikes it carried out from May 2022 to February 2023.
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