India's banking system is currently experiencing a substantial liquidity surplus exceeding Rs 5 trillion, primarily fuelled by extensive government spending and bond redemptions, prompting market expectations for the Reserve Bank of India to escalate Variable Rate Reserve Repo operations to effectively manage these excess funds.
Key Points
- India's banking system has maintained a liquidity surplus above Rs 5 trillion for five consecutive days, reaching Rs 5.25 trillion.
- The surplus is primarily due to approximately Rs 3 trillion in inflows from year-end government spending and redemptions of government securities.
- Market participants anticipate the RBI will increase Variable Rate Reserve Repo (VRRR) operations to absorb the excess liquidity, as the Weighted Average Call Rate (WACR) is below the repo rate.
- The RBI aims to keep the liquidity surplus between 0.6-1.1 per cent of deposits to maintain a 5-10 basis point spread between the WACR and the policy rate.
- The 10-year benchmark government bond yield eased to 6.87 per cent, influenced by declining crude oil prices and US Treasury yields.
Surplus liquidity in the banking system — measured by banks parking funds in the Reserve Bank of India"s liquidity adjustment facility — continued to stay over Rs 5 trillion for the fifth straight day, data released by the central bank showed.
The surplus was Rs 5.25 trillion on Monday, followed by Rs 5.13 trillion on Tuesday.
The weighted average call rate (WACR), which is the operating target of monetary policy, was at 5.08 per cent on Wednesday, as compared to 5.04 per cent on the previous day.
Factors Driving Liquidity Surplus
Market participants said inflows worth around Rs 3 trillion, driven by year-end government spending and redemptions of government securities amounting to Rs 86,403 crore and Rs 34,791 crore, pushed the surplus beyond Rs 5 trillion.
"Government spending of around Rs 3.5 trillion — around Rs 1.2 trillion in form of security redemption — and some decrease in the cash in circulation led to widening of the surplus," said VRC Reddy, treasury head, Karur Vysya Bank.
RBI's Expected Response
With the WACR currently below the repo rate of 5.25 per cent, market participants expect the central bank to step up Variable Rate Reserve Repo (VRRR) operations to suck out the surplus liquidity.
In its Monetary Policy Report, the central bank noted that maintaining liquidity surplus in the range of 0.6-1.1 per cent of deposits would likely keep the spread between the WACR and the policy rate at 5-10 basis points.
Market Reactions and Outlook
Meanwhile, the yield on the 10-year benchmark government bond eased by 7 basis points to 6.87 per cent, tracking a decline in crude oil prices and US Treasury yields, against the previous close of 6.94 per cent on Monday.
Bond and forex markets were closed on Tuesday on account of Ambedkar Jayanti.
Dealers said profit booking limited further gains in bond prices.
"Since last closing, crude prices fell and US treasuries were also down by 8 bases. Now again, second round (of ceasefire talks) is building up over the weekend," said a dealer at a primary dealership.
Crude oil prices fell to as much as $95 per barrel after US President Donald Trump announced a second round of ceasefire talks with Iran in Pakistan.
The rupee ended flat at 93.38 per dollar after opening 20 paise stronger than its previous close.
Forex dealers said firm dollar demand from importers and oil marketing companies led the local unit to pare its gains towards the end of the session.
