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Is India’s Banking System Facing a Liquidity Squeeze? Here’s What You Need to Know
India’s banking system is currently facing severe liquidity crisis, raising concerns among market participants and economists. As of December 20, deficits rose to Rs 2.27 trillion the highest level since April 2016 a situation reminiscent of earlier monetary pressures, which have led the Reserve Bank of India (RBI) to respond immediately.
To address the deflationary environment, the RBI recently injected Rs 1 trillion ($12.01 billion) through a seven-day variable rate repo (VRR) sale, the first of its kind they were so involved in six months. Further such sales are expected soon, reflecting the central bank’s deeply troubling financial shocks. But is it causing this sudden push?
One major source of support is revenue from advance taxes and Goods and Services Tax (GST) liabilities. These fiscal commitments drove the currency out of the system, causing a severe shortage of money. Prasanna B., head of research at ICICI Securities Primary Dealership, says the impact of GST is likely to continue, so further RBI intervention will be required. He suggests that the RBI should roll over the repo for at least another week to avoid further pressure till the month-end deficit stabilizes the situation.
Despite RBI’s recent intervention, the rate has continued to rise overnight, staying at the upper end of RBI’s policy range. This indicates that the financial crisis is more severe than initially expected. There is growing speculation that call rates could rise further if the central bank does not continue to raise the VRR, casting doubt on the RBI's liquidity position. Prasanna emphasizes the need for continued support, especially given the prolonged and difficult conditions throughout December.
The RBI's recent move is part of an aggressive demonetization program launched in August, aimed at balancing the need for adequate liquidity in the banking system with inflation increasing and disturbing but the current crisis suggests that this approach may need to be adjusted in the short term. Banks, meanwhile, are exploring alternative ways to meet their deposit needs, such as raising funds through certificates of deposit.
Looking ahead, the economic shock is expected to continue in the medium term as well, with some relief likely to come as soon as the first quarter of 2024, according to Swati Arora, chief economist HDFC Bank points out. As the situation evolves, decisions of the RBI will be closely scrutinized, and the markets hope for positive intervention from time to time to avoid further stress on the monetary system.
In conclusion, the Indian banking system is indeed going through tough times. The actions of the central bank in the coming weeks will be critical in determining whether the region can weather the storm successfully or require a more costly intervention. As the year draws to a close, all eyes will be on the RBI and its strategies for dealing with this hyper-monetary situation.
Thank you.
Regards,
Muskaan Bhatter,
Kautilya, IBS Mumbai.
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