The liquidity in the banking system could ease in the coming week due to an increase in government spending – a development that would be the key for the Reserve Bank of India (RBI) to decide whether to extend the incremental cash reserve ratio (I-CRR) mandate for banks.
There are signs of improvement in the liquidity scenario as banks parked Rs 25, 833 crore with the RBI.
Market participants expect liquidity to gradually improve by the end of the month or during the first week of September, aided by government spending.
The RBI has been leveraging liquidity conditions to tame inflation.
The liquidity in the banking system slipped into deficit last week as the RBI decided to withhold a significant portion of banks' surplus funds to curb inflationary pressures exacerbated by the outflow of taxes.
During the August review of the monetary policy, the RBI mandated scheduled banks to maintain an additional 10 per cent CRR on their incremental net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023.
The I-CRR mandate came into effect from the fortnight beginning August 12 and the decision, which is temporary, will be reviewed on or before September 8.
The withdrawal of Rs 2000 banknotes announced in May is one reason for the disproportionate expansion in the banking system liquidity, which prompted the central bank to suck out liquidity with an incremental CRR.
“The liquidity will gradually start improving over the next few days.
"The current tightness is on dual account of I-CRR and GST (goods and services tax) payment. As the government starts spending money, the liquidity will start gradually coming back into the system.
"It will be interesting to see if the RBI rolls over the I-CRR next month.
"September will also have outflows due to advance tax payment,” Vijay Sharma, senior executive vice-president at PNB Gilts, said.
According to the RBI data, the central bank injected Rs 23,111 crore on Wednesday, followed by Rs 23,644 crore, and Rs 15,552 crore.
Banking system liquidity went into deficit on Monday for the first time in the current financial year.
“We are expecting it to be so for some time. When government spending and GST collection will come back to the system, it will ease out a bit.
"It is a temporary measure but we don't expect any VRR (variable rate repo) to happen.
"Only incremental CRR may be reduced in steps, say, from 10 per cent to 5 per cent, and then be withdrawn,” said Arun Bansal, executive director and head of treasury at IDBI Bank.
“I don't expect any VRR to happen because any variable rate repo will take out the purpose of incremental CRR. Because this temporary negative liquidity is just because an outflow happened,” he added.
Meanwhile, the RBI announced a 14-day VRRR (variable rate reverse repo) auction on Friday because there was a reversal of the 14-day VRRR, which the RBI conducted on August 11.
However, the auction saw limited response from banks. Banks parked Rs 22,419 crore against a notified amount of Rs 1 trillion at a weighted average rate of 6.49 per cent.
“From September onwards there's some government securities which will mature that should also help in improving liquidity.
"But obviously it's a function of how credit growth takes place how deposit growth is panning out all those factors will play out for the liquidity,” head of treasury at a private bank said.
The liquidity situation in the first few days of the week remains crucial for the central bank to decide whether to extend the I-CRR mandate before the festival season spending begins.