Liquidity is becoming a structural issue again
RBI will have to judge whether the phenomenon in rising trade deficit, weak INR and falling bank deposits is temporary. If it is not seen as temporary, RBI has to infuse liquidity into the system. The best option for infusing liquidity into the system in by a CRR (Cash Reserve Ratio) cut. A 0.5% cut in CRR from 6% to 5.5% will release around Rs 55,000 crores into the system, which can help ease liquidity and keep it from becoming too tight. RBI had used bond purchases last year as a liquidity tool, but bond purchases in an inflationary environment is questionable, as bond purchases cannot be reversed while a CRR cut can be reversed.
Liquidity conditions are turning negative all over again. Bids for repo at 8.5% in the LAF (Liquidity Adjustment Facility) auction of the RBI averaged Rs 110,000 crores last week on a daily basis. This is the highest daily average bids for repo seen this fiscal and is twice the comfort levels of 1% of NDTL (Net Demand and Time Liabilities) of the RBI. Liquidity could have been impacted, as last week was a holiday shortened week with only three working days and was also the first week of the reporting fortnight. However the sharp rise in bids for repo does indicate that liquidity is becoming a problem all over again. RBI needs to take measures to address the liquidity issue before it gets out of hand.
Liquidity pressures are becoming more apparent despite a government that is borrowing and spending money. The government is running an overdraft of Rs 52,000 crores with the RBI as of 4th November 2011. Government running an overdraft with the RBI is positive for liquidity as the overdraft indicates that the government has already spent the money.
Liquidity is being affected structurally by a) rising trade deficit b) weakening Indian Rupee and c) falling bank deposit growth. Trade deficit for the month of October 2011 was the highest ever at USD 19.6 billion. The trade deficit for the month of September was USD 14.1 billion and for the month of October 2010 was USD 11.2 billion. Rising trade deficit increases demand for US Dollars (USD) and higher demand for USD impacts liquidity as rupee liquidity is sucked out of the system.
Higher trade deficit coupled with negative portfolio flows is impacting the Indian Rupee (INR). The INR at Rs 50.12 to the USD is trading above the psychological levels of Rs 50. The INR has depreciated by 13% against the USD in just over three months. Portfolio flows have been negative in the last three months with FII’s being net sellers of over USD 1.2 billion (equity plus debt). The on going Eurozone crisis is also impacting the INR due to risk aversion trades and is having a negative effect on INR liquidity as demand for USD increase.
Bank deposit growth has fallen over the last one month. Deposit growth has fallen by 1.2% in the period September 30th to October 28th 2011. Deposits have fallen by close to Rs 70,000 crores in this period. Falling bank deposit growth is negative for liquidity as money is going out of the banking system.