‘Excess liquidity may be a concern’

It is likely that the RBI would take steps to reduce surplus liquidity, say analysts

With the central bank widely expected to keep interest rates unchanged in the new fiscal year’s first bimonthly monetary policy review on Thursday, markets are keenly waiting to see what steps the RBI may take to tackle surplus liquidity in the banking system.

Post demonetisation, deposits increased by ₹4.27 lakh crore. Deposits grew 13% year-on-year till March 17. Credit growth was 4.4%. Foreign investors have invested close to ₹45,000 crore in equities since February. According to an estimate by State Bank of India, average cash withdrawals declined in March as compared with January and there has been a permanent liquidity injection of ₹1.7 lakh crore in the system. The surplus liquidity in the system is estimated to be about ₹4 lakh crore.

“The surplus liquidity in the system is likely to rise further when the government starts spending in the new fiscal year,” Abheek Barua, chief economist, HDFC Bank, wrote in a report.

“If the rupee continues to appreciate, there could be added pressure as the RBI will start buying dollars to cap gains in the currency. Leaving the surplus problem unattended could lead to investments into riskier assets... Hence, it is highly likely that the RBI will implement measures to soak up excess liquidity,” he said.

One way to drain the excess liquidity is to raise the cash reserve ratio (CRR) which is at 4%. CRR is the proportion of deposits that banks have to keep with RBI.

“We do not believe that a hike in CRR is feasible given the abundance of liquidity,” said Dhawal Dalal, CIO-Fixed Income, Edelweiss Asset Management.

The proposed standing deposit facility (SDF) could be a useful tool to tackle liquidity. SDF is a mechanism to drain surplus cash at a rate lower than the repo rate without the need for any collateral. The implementation of SDF requires an amendment to the RBI Act. Hence, it is felt that the RBI could start draining liquidity from banks at a lower rate so that it would bring interest rates down.

“The RBI is constantly absorbing excess liquidity at around repo rate of 6.25%, which is also the LAF (liquidity adjustment facility) rate. Is there a thought process within the RBI to gradually trend LAF rates towards the reverse repo rate, which is 5.75%” Mr. Dalal observed.

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Printable version | Aug 6, 2020 7:51:07 AM |

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