Liquidity conditions are looking more positive on the back of weak credit growth, RBI bond purchases and government spending. If the falling liquidity trend continues, the market will, for the first time in two years, see sustained positive liquidity conditions. Positive liquidity conditions will change the whole nature of some segments of the market, as markets will then start lending to the RBI at reverse repo rates of 7% against borrowing from the RBI at repo rates of 8%. The sudden drop in 100bps in market rates will bring down overnight money market rates, yields on money market securities and will improve outlook on corporate and government bonds.
Liquidity as measured by bids repo in the LAF (Liquidity Adjustment Facility) auction of the RBI is seeing a falling trend in the April 2012 till date period. Bids for repo have come off from levels of Rs 140,000 crores to levels of Rs 11,500 crores as of 6th July 2012. The sharp fall in the demand for liquidity from banks (banks borrow funds from RBI at repo rates through the LAF auction to meet their daily requirements for funds) looks more lasting than temporary in nature.
The reason liquidity conditions are looking better is that RBI has added Rs 79,000 crores of primary liquidity into the system through purchase of government bonds. RBI has been buying bonds in the secondary market and through OMO (Open Market Operation) bond purchase auctions.
RBI’s bond purchases have come at time when banks have hardly seen any credit or deposit growth. In the period 30th March 2012 to 15th June 2012, banks have seen deposits and credit higher by just Rs 1560 crores and Rs 9870 crores respectively. Banks have not seen any leakage from the system from credit growing faster than deposits.
There has been leakage from the system in terms of notes in circulation rising by Rs 47,915 crores in the period under consideration. That leakage has to some extent been negated by liquidity infusion by the RBI.
The government has been spending the money it has been borrowing from the markets (government has borrowed Rs 202,000 crores in the April 2012 till date period) and is flat on balances with the RBI i.e. government is neither surplus nor in deficit with the RBI. Government activity has been neutral on the liquidity front.
RBI has not yet released data on foreign exchange intervention over the last two months. In April 2012 RBI had sold a net of USD 275 million an amount that hardly impacts liquidity. RBI has used other means to counter the record fall in the Rupee levels (Rupee crossed record lows of Rs 57 to the USD in June 2012) including freeing NRI deposit rates and encouraging capital flows through higher limits in ECB (External Commercial Borrowing) and government bonds. It does not seem likely that RBI has been selling USD heavily to protect the INR given that the Rupee has been allowed to fall to record lows.
FII’s have been net buyers of equities and bonds since April 2012 with net purchases of USD I billion. FII activity has been positive for liquidity. Trade deficit for April 2012 was USD 13.4 billion down from USD 14.3 billion seen in March 2012. Trade deficit is seen as negative for liquidity as it involves outflow of USD. A weaker Rupee impacts oil import bill but the fall in oil prices by 20% since April 2012 has negated the increased oil bill due to a weaker Rupee to a large extent.
On the margin, taking RBI bond purchases, bank deposit and credit growth, growth in notes in circulation, government spending, FII activity and trade deficit liquidity is still in deficit as seen from the fact that the market is still borrowing from the RBI on a daily basis. However the drivers of liquidity including trade deficit (a weak Rupee will help exports) are looking more positive for liquidity than negative for liquidity and there is a good probability of liquidity turning positive in the coming weeks.