Indian banks are optimistic about a turnaround in the liquidity situation as the new government settles in. The banking system had been grappling with a significant liquidity deficit in recent months, primarily due to a slowdown in government spending pre-election and outflows related to the Goods and Services Tax (GST).
This deficit had forced banks to rely heavily on the Reserve Bank of India (RBI) for support. In May alone, the RBI injected a record-breaking ₹9 trillion into the system through Variable Rate Repo (VRR) auctions – the highest infusion witnessed so far this year. The demand for these auctions was immense, with banks placing bids worth a staggering ₹13.54 trillion against the notified amount.
The liquidity crunch peaked in May, with the deficit reaching ₹2.32 trillion. However, there were signs of slight improvement towards the month-end, with the deficit declining to ₹1.38 trillion on May 28th. Analysts attribute this improvement to a pre-cursor of increased government spending expected with the new government taking charge.
“The days of huge liquidity deficit are over for banks,” said a senior public sector bank official, on condition of anonymity. “We expect government spending to pick up pace from the second week of this month onwards.” This optimism stems from the historical trend of increased government spending in the latter half of the financial year, which typically infuses liquidity into the banking system.
The improved liquidity scenario is expected to have a positive ripple effect across the financial sector. A leading credit rating agency, India Ratings and Research, believes that an easing liquidity situation will boost commercial paper (CP) issuances in the coming months. This will benefit corporates seeking funds for short-term needs.
Furthermore, the RBI’s recent record dividend transfer to the government (₹2.1 trillion for 2023-24) is expected to further ease pressure on short-term interest rates. This, in turn, could lead to a reduction in banks’ reliance on certificates of deposit, which will improve the overall money market situation.
Experts caution that while the outlook appears positive, some challenges remain. The upcoming tax outflows in March could put temporary pressure on liquidity. However, the overall sentiment in the banking sector is one of cautious optimism, with the expectation that the new government’s spending will be the key driver in easing the liquidity situation.
