Liquidity Deficit in the Banking System
India’s banking system liquidity slipped into a deficit in December of 2024, making it the first shortfall since June of the same year even after easement of the CRR by RBI which infused Rs. 1.16 lakh crore. The banking system liquidity deficit reached Rs. 2.43 trillion as of 23rd December, 2024. This meant that banks did not have sufficient funds to lend and sustain day to day operations.
There are numerous reasons as to why despite RBI efforts, banking system liquidity has reduced significantly. One of the pressing reasons for this reaction would be the issue of advance tax payments, that is, businesses have made sizable amounts of tax payments which reduced the cash in circulation within the banking system. Another major factor is the RBI’s regular interventions in the foreign exchange market. Recently, the RBI sold U.S. dollars to stabilize the rupee which then led to the erosion of rupee liquidity in the near term with crossing new lows multiple times reaching Rs. 86.51 to a dollar this tuesday (31st, December, 2024). Furthermore, the factor that influenced banking system liquidity is the festive spending season which led to increased cash withdrawals by individuals, decreasing the deposits held with banks. This type of seasonal demand is typical but can put stress on liquidity during peak times. Another factor linked to liquidity crunch is the decline of currency in circulation in the economy, which increased to more than Rs. 500 billion in 2024 which further limited the available funds with banks.
The liquidity shortfall comes after many fluctuations in liquidity in the past one year. The RBI addressed this deficit by way of policy actions which included a 50 basis point cut in the CRR to 4% from 4.5% in December which injected around Rs. 1.16 lakh crore but this is not enough to offset the cash withdrawals and interventions. This CRR requirement came into implementation in two tranches of equal basis points, one from 14th December and 28th December.
Despites the liquidity shortfalls, RBI utilized variable repo rate (VRR) auctions to stabilize borrowing costs close to policy repo rate. During the month of December, average call rate has been around 6.55% which happens to be just 5 basis points above the repo rate. On the other hand, experts have stated managing call rates through VRR auctions is only a temporary solution in handling liquidity in the economy.
While commenting on the liquidity issue, Siddhartha Sanyal, chief economist at Bandhan Bank, stated that for the situation to improve, government spending should increase significantly in Q4. Further, the CRR requirement rate cut would also impact liquidity in a positive manner. In the near term it would be important to meticulously eye the trends in USD-INR and the near possibility of RBI intervention in the foreign exchange market which is possible in upcoming weeks/months.
Coming to the journey of rupee so far this year, rupee’s trajectory has been weakening from the past few months, with rupee slipping below record lows at numerous occasions. Furthermore, India’s foreign exchange reserves have depleted by almost USD 60 million by 20th December, 2024 which shows RBI continuous intervention in the foreign exchange market.
Additionally, to counter persistent liquidity crunch in the banking system, RBI has already hinted on further rate cuts in the first half of 2025. Market experts have stated that liquidity deficit can affect the credit flow which limits the impact of any further rate reductions. Another tool the RBI could employ to ease the liquidity is the Open Market Operations (OMO). RBI could do this by announcing the open market bond purchases which would further induce liquidity directly into the economy by way of government bond issuance. Looking ahead, market participants expect spending to expand by about ₹1 billion from January to March 2025. This increase in demand will be driven by other sources, inflation and other monetary factors are involved and thus the demand for funds may increase, whereby the liquidity of the system becomes tight again.
In conclusion, the deficit in the Indian banking system by December 2024 is a significant development, which means that sustainable measures are needed to ensure liquidity in the coming months, though RBI has already taken steps to address the issue, including reducing CRR and variable rate repo auctions. The idea is to stabilize the monetary environment by implementing innovative measures such as market bond purchases and further reductions in CRR necessary as the monetary system faces ongoing pressures from financial flows, currency circulation and foreign currency intervention, therefore to ensure access to funds appropriate, it will be critical to the successful delivery of monetary policy and overall financial health.
The image added is for representation purposes only
