Why India's banking system is facing a liquidity crunch?
What's the story
India's banking system is facing a temporary liquidity shortage, which is expected to improve in the coming days. The recent tax outflows have pushed the surplus down to its lowest level since March-end. However, analysts believe that government spending and bond redemptions will counter this effect. A phased reduction in cash reserve ratio (CRR) starting October will also support recovery efforts.
Tax effects
Liquidity surplus fell to ₹70B
The liquidity surplus fell to ₹70 billion ($794 million) on September 21, the lowest since March-end. This comes after nearly ₹2.6 trillion exited owing to income tax and GST payments. The cash in the banking system determines market interest rates, including those of consumer loans. Vivek Kumar, an economist at Quanteco Research, said this shortage is likely temporary as government spending should help neutralize its impact over the coming week.
RBI perspective
RBI comfortable with liquidity surplus of around ₹2.5T
The Reserve Bank of India (RBI) is comfortable with liquidity surplus of around 1% of the banks' deposits, which is roughly ₹2.5 trillion. The liquidity surplus had averaged above that level in recent weeks before the tax-related outflows. Gaura Sengupta, Chief Economist at IDFC First Bank, expects liquidity to rise over the next few weeks as government spending picks up and banks' CRR is lowered.
CRR adjustment
CRR cut to begin from October
The CRR, which is the amount of money banks have to park with the RBI, will be cut by a total of 100 basis points in four equal installments from September to November. The next cut will come into effect on October 4. Kumar expects liquidity surplus to return to ₹2 trillion-₹2.5 trillion before that date.