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The liquidity deficit in the system, as reflected from the average daily borrowings from the RBI's repo window, has more-than-doubled to Rs.1.14 lakh crore in the second half of 2011-12, compared with only Rs 52,000 crore in the first half. The liquidity crunch in the system in the last three months had reached such serious proportions that the RBI had to reduce the CRR by 75 basis points on March 10, 2012, in an out-of-turn monetary action.
This measure was a follow-up to the relaxation of CRR by 50 basis points in the third quarter review of monetary policy on January 25, 2012. The reduction in CRR by 125 bps released Rs 80,000 crore of liquidity into the system. The RBI, before the reduction of CRR, used to maintain that it prefers liquidity to be in the deficit mode, but within tolerable levels, as it helps better transmission of rate hikes to control inflation. The tolerable level of liquidity deficit defined by RBI is 1 per cent of the NDTL of the banking system, which turns out to around Rs 57,000 crore.
As liquidity shortage has breached its tolerance, RBI, has reduced CRR on two occasions in the recent past. Notwithstanding the two cumulative reductions, banks on an average borrowed Rs 1.50 lakh crore from the RBI on a daily basis between March 10 and March 31, 2012. What have been the drivers of persistent liquidity shortage in the system in the last six months?
DEPOSIT-CREDIT MISMATCH
Borrowings from the repo window are a facility offered by the RBI to banks to meet temporary mismatch in their funds inflow and outflow. This temporary mismatch can turn into a structural problem if growth in deposits considerably falls short of growth in advances.
If we consider the period between November 2011 and March 2012, when liquidity deficit in the system was acute, credit growth has outpaced deposit growth by only around Rs 1,100 crore.
Thus, the liquidity shortage experienced in the system is not indicative of a structural mismatch between the core activities of resource mobilisation and credit deployment by the banks.
FOREX INTERVENTION
The persistent liquidity deficit in the second half of 2011-12 is attributed to host of factors; chief among them is the sucking up of liquidity arising from the forex market intervention of the RBI to protect the rupee's external value.
As the rupee depreciated by 20 per cent between August and December 2011, RBI sold dollars in the market to protect the value of the rupee vis-à-vis the dollar, and in the process sucked up liquidity.
However, the open market purchase of G-Secs by RBI, though, hasn't fully, but to a great extent, sterilised the impact of the RBI's intervention in the currency market in the months of acute liquidity shortage. What then explains the liquidity deficit in the system?
GOVERNMENT BORROWING
Perhaps the primary reason for the liquidity shortage lies in the overshooting of government's borrowings in the second half of 2011-12.
Government's borrowings through issue of dated securities at Rs 2.5 lakh crore in the first half of 2011-12 were as per the estimates outlined in the Budget 2011-12.
However, in the second half of 2011-12, Government issued G-Secs worth Rs 2.78 lakh crore which is Rs 1.11 lakh crore more than the budgeted Rs 1.67 lakh crore.
Critics to this line of argument will point out that funds mopped up by the issue of G-Secs will eventually percolate through the banking system as government spends them.
While this may be true, it is the recurring borrowing, to the tune of Rs 50,000 crore every month between November 2011 and February 2012, which has created liquidity stress in the system.
Some people have put forward an argument that the increase in NPAs, the number of CDR cases and amount involved under CDR mechanism has resulted in poor cash flow for the banks, and that, in turn, prompted the banks to resort to the repo window for their liquidity needs.
While this line of reasoning may partially hold true, the primary driver of the liquidity deficit seems to be the excessive government borrowings in the second half of 2011-12. The liquidity shortage is only a symptom of the large malaise of higher fiscal deficits seen in recent times.
Higher fiscal deficit ultimately makes the RBI's decision on the timing and quantum of rate easing much more difficult.
(The author teaches Economics at the Xavier Institute of Management, Bhubaneswar. Views are personal.)
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