India is on track to resolve one of its most severe liquidity deficits in recent years, following aggressive interventions by the Reserve Bank of India (RBI).
The central bank has injected approximately $68 billion into the financial system since late January, helping to ease a liquidity shortfall that had reached alarming levels.
The measures are expected to create a liquidity surplus by the end of March, improving interest rate transmission and providing support to the economy.
The liquidity crunch, measured through banks' borrowings from the RBI, has gradually eased. As of March 6, the shortfall had reduced to 793 billion rupees ($9 billion), significantly lower than the nearly 15-year high of 3.3 trillion rupees recorded in late January.
A Bloomberg Economics index tracking these figures indicates that the worst phase of the liquidity deficit may be over.
A significant portion of the improvement is attributed to the RBI’s strategic steps, which include open market bond purchases, variable rate repurchase operations, and foreign exchange swaps.
These measures have injected a large amount of liquidity into the banking system, ensuring that funds remain available for lending and investment.
The RBI has also announced further bond purchases and forex swaps for March, indicating its commitment to maintaining stability in the financial system.
The improving liquidity conditions are expected to aid better transmission of interest rate cuts and provide relief to businesses and consumers.
As lending rates stabilize, the economy could benefit from increased credit availability, particularly at a time when India is facing its slowest expansion in four years.
Economists believe that the RBI is actively working towards shifting the liquidity position to a surplus. Gaura Sen Gupta, Chief Economist at IDFC First Bank Ltd., stated that the RBI’s focus is on ensuring adequate liquidity to facilitate the smooth transmission of policy rate adjustments.
She anticipates a liquidity surplus by the end of March and estimates that the central bank may inject an additional 2 trillion rupees in the next fiscal year starting April 1.
One of the key reasons behind the liquidity crunch was the RBI’s intervention in the foreign exchange market to stabilize the rupee. As global economic uncertainties increased, the central bank sold dollars to prevent excessive depreciation of the rupee.
This led to a drain on liquidity in the banking system, exacerbating the shortage of funds.
Additionally, the financial system is preparing for significant cash outflows as companies make quarterly advance tax payments to the government before the end of the financial year in March.
This could temporarily tighten liquidity, but the RBI’s ongoing measures are expected to cushion the impact.
The central bank’s actions have already started showing results in the money market. Banks' overnight borrowing rates have dropped below the policy rate in recent days, reflecting improved liquidity conditions.
Earlier in January, the overnight rate was nearly 40 basis points above the RBI’s policy rate, indicating severe financial stress.
Financial market experts have welcomed the RBI’s proactive approach. Suyash Choudhary, Head of Fixed Income at Bandhan AMC Ltd., noted that the recent liquidity injections were much larger than market expectations.
He suggested that the RBI would likely continue injecting funds if liquidity conditions do not improve as anticipated.
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