The banking system’s liquidity slipped into deficit after remaining in surplus for nearly three months, weighed down by advance tax outflows and higher currency leakage.
Consequently, the weighted average call rate (WACR) — the operating target for monetary policy — rose to 5.38 per cent on Tuesday, compared with 5.33 per cent on Monday.
The RBI injected Rs 1.41 trillion into the banking system on Tuesday through a seven-day variable rate repo (VRR) auction to ease transient liquidity tightness. VRR auctions allow banks to borrow funds from the RBI against government securities at market-determined rates, helping the central bank manage short-term liquidity in the financial system.
The central bank actively uses variable rate repo and reverse repo operations to keep overnight rates within the liquidity adjustment facility (LAF) corridor, bounded by the standing deposit facility (SDF) rate at the lower end and the marginal standing facility (MSF) rate at the upper end, while ensuring that the weighted average call rate remains closely aligned with the policy repo rate, the operating target of monetary policy.
Market participants said the liquidity squeeze was largely driven by quarter-end advance tax payments, which led to a sharp rise in government cash balances and drained funds from the banking system.
“The liquidity deficit is largely a function of advance tax outflows and elevated currency leakage. As government spending gathers pace towards month-end, liquidity conditions should move back into surplus,” said Gaura Sen Gupta, chief economist at IDFC FIRST Bank.
Currency leakage has also contributed to the tightening, with cash withdrawals tracking higher than in the corresponding period last year. Analysts attributed this partly to resilient rural demand and increased withdrawals linked to state government cash-transfer schemes, where beneficiaries tend to withdraw a larger share of funds in cash.
Despite the temporary deficit, liquidity conditions are expected to improve towards the end of the month as government spending picks up and funds return to the banking system.
While observing that the liquidity situation in the banking sector moderated in May, the State of the Economy report released by the RBI on Monday said this was due to the continued rise in currency in circulation, the Reserve Bank’s forex operations and the build-up of government cash balances.
According to the latest data, currency in circulation has grown 12.1 per cent year-on-year to cross Rs 43 trillion as of 31 May.
The situation is expected to ease going ahead, as the drawdown of government cash balances is expected to augment system liquidity following the RBI’s surplus transfer to the government, the report said.
“The deficit is temporary. Government spending will soon kick in, which will improve liquidity conditions,” said a money market dealer at a state-owned bank.
They also expect capital inflows to support liquidity over the coming months, including inflows related to the FCNR(B) window, which remains open until September.
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