Clipped from: https://www.financialexpress.com/opinion/liquidity-matters/4089609/
As system liquidity turns negative, rate cuts alone are proving insufficient to ease borrowing costs
RBI Unleashes ₹2.9 Lakh Crore Liquidity Lifeline as Year-End Cash Crunch Spikes Bond Yields
With benchmark bond yields having hit a nine-month high of 6.67% despite a 125 bps cut in the repo rate, the Reserve Bank of India (RBI) has been compelled to infuse liquidity into the system. The central bank has said it would buy bonds worth 2 lakh crore in four tranches and also do a dollar swap for $10 billion or around 90,000 crore.
Having been entrenched at levels of 6.5-6.6%, yields retraced after the RBI’s announcement but they continue to hover around the 6.56% mark. One reason why the bond markets have been under the weather is that foreign portfolio investors (FPI) have been offloading their holdings. The net selling for December is estimated at close to 11,000 crore. It is clear, as seen in the spike in the overnight lending rates, that the system is short of liquidity in the midst of the busy season.
It moderated from surplus levels of 4 lakh crore in July to around 1.3 lakh crore by the end of November. In early December, the central bank said it would purchase bonds for an amount of 1 lakh crore and conduct a $5 billion dollar swap. But, despite this assurance, by about mid-December, the surplus had turned into a deficit and currently remains in a deficit of 85,000 crore.
Why the System Swung into Deficit
One immediate reason for the shortage is the tax outflows on account of advance tax payments and thereafter for Goods and Services Tax (GST) payments.
But it is also a fact that rupee liquidity has been sucked out due to the RBI’s dollar sales to support the rupee; the central bank spent billions of dollars backing the currency. Again, the demand for bonds from insurance funds and pension funds has been somewhat muted. Also, some states have advanced their borrowings adding to the supply of paper. In fact, there is an expectation that states may advance their borrowings that have been planned for the January- March quarter.
The aggregate supply of paper in the March quarter is not small at an estimated 8.1 lakh crore; of this, 3.1 lakh crore would be the Centre’s share and the bigger amount of 5 lakh crore would be borrowed by the states. Already, borrowing costs for the states have been high and, should liquidity remain tight, the rates could spike further.
Against this backdrop, it looks like more liquidity infusions might be needed and the central bank may need to infuse at least another 1 lakh crore of rupee liquidity in about a month’s time. Else, short-term rates could rise further while at the longer end, the yields might remain at these levels.
The government too should speed up spending so as to add to the liquidity. However, while the RBI does its job, banks must make deposits more attractive to savers by offering better interest rates at a time when money is moving into equities. The growth in deposits has moderated a fair bit from levels of over 13% year-on-year in December 2023 to 10.2% year-on-year as of end-November. The growth, through 2025 so far, has been in the range of 9.5-10.8%, with banks pruning interest rates on deposits after the RBI kicked off the rate cut cycle in February. Perhaps some tax breaks on deposits will do the trick.
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