India is making significant progress in addressing one of the most severe liquidity shortages in its financial system, thanks to decisive actions taken by the central bank to infuse cash. As of March 6, the liquidity deficit, indicated by the amount borrowed by banks from the central bank, has decreased to 793 billion rupees ($9 billion), down from a nearly 15-year peak of 3.3 trillion rupees recorded in late January, according to a Bloomberg Economics index.
The significant reduction in liquidity can be largely attributed to the actions of the Reserve Bank of India, which has implemented measures since late January that will result in a cash infusion of approximately $68 billion. Enhanced cash conditions are expected to facilitate more effective transmission of interest rate reductions and bolster the economy as it approaches its slowest growth rate in four years.
India’s liquidity deficit has increased, in part due to the central bank’s dollar sales aimed at protecting the rupee from international pressures as the local currency continues to reach new lows. The banking sector is preparing for cash outflows linked to quarterly advance tax payments that companies must make to the government before the end of the financial year in March.
This year, the Reserve Bank of India has implemented several measures to inject liquidity into the banking system, including auction-based open market bond purchases, variable rate repurchase agreements, and foreign exchange swaps. Additional bond purchases are planned for this month, along with a forex swap.
These liquidity measures have contributed to a decline in banks’ overnight borrowing rates, which have fallen below the policy rate in recent days, while yields on two-year government bonds have also decreased. Earlier in January, the overnight rate was nearly 40 basis points higher than the RBI’s policy rate.
Recent cash infusions have successfully lowered banks’ overnight borrowing rates to below the policy rate over the past few days, while yields on two-year government bonds have also decreased. Earlier in January, the overnight rate was nearly 40 basis points higher than the RBI’s policy rate.
An expert noted in a report that the additional measures introduced by the central bank this week were significantly larger than what the market had anticipated. He indicated that this implies the RBI is prepared to provide further liquidity if conditions do not improve as anticipated.
“The RBI’s latest measures indicate that its focus is on making system liquidity positive to enable transmission of rate cuts,” he said.