Liquidity Tightens: Why Economists Don't Expect RBI To Intervene

Economists expect banking liquidity to remain tight amid normalisation of monetary policy.

Banking liquidity was in deficit of Rs 200 crore on Oct. 25, but went back into surplus a day later. It ranged closer to Rs 7 lakh crore a year ago, and reached a surplus of over Rs 9.9 lakh crore in September last year. Since then, the liquidity has continued to tighten.

So, it is understandable that the RBI would prefer banking system liquidity to move towards neutral and then tighten, given that it has already been consistently hiking the policy rate, Nandi said.

Consequently, the RBI’s forex intervention has so far taken on the dual role of draining domestic liquidity, and in the process helping with stealth normalisation of monetary policy, Nandi added.

Credit growth, too, has witnessed a sharp revival in the past 10 months, rising to a decade high of 18% year-on-year in October on a broad-based pickup, led by retail, working capital demand and substitution effects from capital markets to banks, besides likely added buoyancy on festive demand, said Radhika Rao, senior economist at DBS Bank.

With deposit growth lagging this upturn at 9.6% year-on-year, liquidity has tightened, compounded by temporary drivers like lower government spending, higher currency in circulation in midst of festivities and indirect tax outflows.

Borrowing costs are up.

• The weighted average lending rate on fresh rupee loans of scheduled commercial banks increased to 8.3% in August 2022, from 8.05% an year ago, according to data from the RBI on lending and deposit rates of scheduled commercial banks. 

• The weighted average lending rate on outstanding rupee loans increased to 9.1% in August 2022, from 8.98% an year ago.

• One-year median marginal cost of fund based lending rate increased to 7.75% in September, from 7.25% an year ago.

The benchmark repo rate has risen 190 basis points to 5.9% currently.

The central bank, reportedly, has injected about Rs 1.35 lakh crore since late last week to thaw cash conditions, Rao said. However, more directed support has not yet been undertaken, likely because of a higher tolerance for rise in money market rates.

The weighted average call rate has been rising to hover close to the upper end of the repo rate corridor this month. This has also driven up other short-term rates including commercial papers and certificate of deposits as well as corporate yields, reinstating premiums. Pressure to raise deposit rates further is likely to build, and will prompt banks to lower reliance on bulk deposits, Rao explained.

Liquidity remains surplus, with an average daily net absorption of Rs 1.1 lakh crore under the Liquidity Adjustment Facility last month up to Sept. 28, the RBI stated in its monthly bulletin for October. As government expenditure picks up on the back of high GST and direct tax collections, the system liquidity will go up further, it said.

Even as the nominal policy repo rate has been raised by 190 basis points so far, the policy rate adjusted for inflation trails the 2019 levels, the central bank explained in its last bulletin. As such, the overall monetary and liquidity conditions remain accommodative and, hence, the Monetary Policy Committee decided to remain focused on withdrawal of accommodation, it said.

While strong growth in credit growth is encouraging, any incremental lift hereon is likely to face speed bumps by way of an aggressive rate-hiking cycle, slower deposit growth and passage of seasonal drivers, with an eye also on the durability of broader economic momentum to sustain this demand, Rao said.