Banking System Liquidity Likely To Remain In Deficit In Second Half: Report

India’s banking liquidity slipped into deficit on Tuesday for the first time in over three years, according to a data from the Reserve Bank of India

As of Tuesday, the systemic deficit stood at Rs 21,800 crore, its highest since May 2019, with tax outflows in past week also squeezing liquidity.

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As credit growth picks up and the circulation of currency notes rises, liquidity in India's banking system may remain in deficit in the second half of this financial year, quoting analysts, Reuters said. A data from the Reserve Bank of India (RBI) stated that India’s banking liquidity slipped into deficit on Tuesday for the first time in over three years.

According to the Reuters’ report, a widening liquidity deficit could lead to a rise in short-term borrowing rates and prompt the central bank to pump in money into the banking system through repo auctions and slow down its interventions in the currency market.

Vivek Kumar, an economist with QuantEco Research, said, "The onset of the festive season and expectation of sequential improvement in economic growth would increase transactional demand for cash." As a result, currency in circulation could jump by Rs 2.2-2.4 lakh crore ($27.52 billion-$30.02 billion) in the second half of the financial year, Kumar estimated.

Meanwhile, the government spending, which boosts liquidity in the market, has been slower than expected despite robust tax collections. "This combination of slow pick-up in government expenditure and buoyant tax collection is reflected in government cash balance," said Gaura Sen Gupta, an economist with IDFC First Bank.

The fiscal year started with a liquidity surplus of over Rs 8 lakh crore in early April. The RBI had said at the time that withdrawal of liquidity would be a "multi-year" process.

As of Tuesday, the systemic deficit stood at Rs 21,800 crore, its highest since May 2019, with tax outflows in past week also squeezing liquidity.

According to Kumar, core systemic liquidity surplus, which also includes the government's cash balance, had reached a peak of Rs 12 lakh crore in September 2021 but has since sharply declined to Rs 3.9 lakh crore. More than half of this drawdown is on account of the RBI's dollar sales to cushion the rupee's fall, he estimated. A negative balance of payment has weighed on overall liquidity.

India's balance of payment was in a deficit of $16 billion as of March 2022, with analysts expecting the gap to widen further in the next few quarters. A large deficit forces the central bank to sell dollars into the market, sucking out rupee liquidity.

The RBI has sold a net of around $39 billion from its foreign exchange reserves between January and July, with reserves shrinking to a two-year low of $551 billion as of September 9, data showed.

"Unless we see reasonable improvement in the balance of payment deficit, liquidity tightness will continue to persist," said Soumyajit Niyogi, director at India Ratings.