The absence of the key driver of economic growth was felt in the first quarter of the year. Analysts are of the view that the Reserve Bank of India’s tolerance for excess liquidity suggests that it may be gradually preparing for a gentler slowdown. monetary policy.
Last week, while stressing that India’s growth story remains intact after a lower-than-expected 6.7% expansion in GDP in the June quarter, central bank Governor Shaktikanta Das reinforced his statement saying that government spending would accelerate for the rest of the year in line with budget estimates.
Banking system metrics suggest that the recovery has been underway steadily over the past few months.
Sharp drop in the Centre’s cash balance
Throughout July, August and so far in September, the banking system has experienced excess liquidity conditions, with the average amount of funds that lenders have parked in the Reserve Bank of India According to an analysis of central bank data, the RBI is hoarding Rs 1.34 trillion on a daily basis. When the RBI mops up funds from banks, it indicates the prevalence of excess liquidity conditions. From a peak of over Rs 5 trillion in May, when elections were in full swing, the government’s cash balance has fallen sharply now, indicating the spending push from the centre.
“The increase in liquidity conditions (surplus) represents a pick-up in government spending after the elections,” said Gaura Sengupta, chief economist, First IDFC Bank“This is reflected in the reduction of the government’s cash surplus to ₹2.3 lakh crore as of August 2024 from a peak of ₹5.1 lakh crore as of May 24.”
Liquidity of the banking system In May and June the economy was generally in deficit mode.
Government spending typically flows through the banking system, increasing the cash held by lenders, although spending reforms by the central government in recent years have reduced that liquidity.
Das had said last week that the headline GDP growth figure for the first quarter had come in lower than expected, perhaps due to subdued spending by the Centre and states during the general elections, which ended in early June.
Borrowing costs, RBI stance
Easier cash conditions in the banking system over the past two months have lowered the weighted average interest rate (WACR), which represents the cost of overnight funds for banks.
“One of the most notable statements from the RBI Governor’s recent speech was that the balance between growth and inflation is very well balanced. This is a significant change from the August policy statement, where he mentioned an unequivocal focus on inflation,” said Anubhuti Sahay, Head of Economic Research at Standard Chartered Bank in India.
“Assuming there are no negative surprises on the inflation front, I think liquidity sentiment is likely to hold and that could take a step forward with a change in stance and then, probably, rate cuts starting at the end of the year.”
The annualised growth rate (WACR), which is the operational target of the RBI’s monetary policy, has averaged 6.38% from July 1 to September 5, 12 basis points lower than the central bank’s repo rate of 6.50%. One basis point is equivalent to 0.01 percentage point.
Higher liquidity and lower cost of overnight funds have pushed down yields on government Treasury bills, which are used as a benchmark for pricing various credit products across the economy. From an auction on June 26 to the latest one on September 4, yields on Treasury bills of different maturities have fallen 17 basis points to 24 basis points, according to RBI data.
RBI Measures
In 2023, when the RBI was faced with a sharp rise in food inflation in the second half of the year, the central bank was reluctant to tolerate excess liquidity in the banking system, given its potential inflationary impact.
In recent months, the RBI has taken some steps to control the quantum of rupee liquidity being added to the banking system through external debt flows. The central bank has conducted open market bond sales worth a total of Rs 18,225 crore through secondary market operations between mid-July and now. However, it has stopped short of conducting large-scale open market sales of government bonds through auctions.
Indian debt markets received net inflows worth $4.8 billion in July and August, official depository data showed.
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