In April, the Indian banking system was filled with liquidity of more than 8 trillion. It is the money that moves between banks and the reverse repo window of the Reserve Bank of India (RBI); That is, overnight parking of additional money. The money got easier, as indicated by the low overnight inter-bank lending rates that apply when banks with excess cash lend to their peers to make up for temporary shortfalls. Even the repo rate, at which banks borrow money overnight from the RBI, was only 4%, which was lower than the inflation rate, meaning a real negative rate of lending. In just five months since then, that liquidity has vanished, and banks are facing shortages. They are desperate for deposits, so the mighty State Bank of India (SBI) has also increased deposit rates in the last one month. SBI’s rate for one-year foreign currency deposits (FCNR-B) has increased by 90 basis points to 3.85%. Banks are now resorting to raising funds through certificates of deposit (CDs), with short-term rates above 6.5%. By mid-September the total mobilization of CDs was approx. 2.5 trillion, whereas a year ago it was just zero.
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What explains this dramatic withdrawal of liquidity and what does it represent? The first is because the RBI started indicating that it was changing its stance from accommodative (i.e. a loose monetary policy) to a “return to accommodative”. Or, to put it simply, the RBI has shifted its focus from supporting growth to controlling inflation. This is the reason why its policy rate has increased by 190 basis points in five months, and is expected to increase by 50 to 100 basis points further. Fall in Rs. It is estimated to have generated sales of $10-15 billion and has taken a lot of liquidity out of the system. The overall decline in RBI reserves is over $100 billion since last September, which is about 18%. This is the biggest fall in emerging market economies, and yet the rupee has fallen to 82 against the dollar. The RBI governor has said that the decline of 67 per cent of reserves was due to revaluation. But that still leaves 33%, most of which may have been sold by the RBI to protect the currency. The third and very important reason for the sharp drop in liquidity is that the demand for credit far exceeds the increase in demand deposits. Credit offtake, growing at 16%, is the highest in nine years, while deposit growth is only 9.5%. This gap between credit and deposit growth is also the highest in 10 years. An increase in credit is usually a leading indicator of the state of a business cycle. Is this indicating an uptrend? What is supporting evidence?
Firstly, e-commerce companies showed a strong 28% growth in sales during the first few days of the festive sale season online shopping. Secondly, growth in e-way bills, the digital trail of commerce, stood at around 35% during August. For inter-state movement of goods, the e-way bills generated showed an increase of 53% for some states like Maharashtra, Tamil Nadu, Gujarat, Karnataka and Uttar Pradesh. Third, GST collections grew by 26% in September, 28% during August, and for six consecutive months before that, the intake was exceeded. 1.4 trillion per month. Based on advance taxes paid, direct tax collection has increased by 30%. Perhaps that is why the finance secretary at the Center recently said that he is confident of meeting or exceeding the fiscal deficit target this year. The government has also announced a marginal drop in its revised borrowing requirement. Fourth, imports of non-oil, non-gold items are also increasing, indicating strong demand. Of course, this is raising concerns given our growing trade deficit.
Automotive sales are growing, though higher at the top level for four-wheelers, while growth in two-wheelers and tractor sales is stagnant or declining.
Thus it may be tempting to conclude that liquidity crunch in the banking sector predicts growth in the business cycle. This conclusion needs to be moderated by other factors.
The fiscal position may not be as smooth as the Finance Secretary had suggested. Note that the Union Cabinet has decided to extend the free food scheme called Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) for another three months, despite opposition from the Finance Ministry. There is additional cost for PMGKAY 44,000 crores. Due to higher oil prices, fertilizer subsidy will be higher in this financial year 2 trillion, although only 1 trillion budget. And then, the higher cost of borrowing due to rising interest rates means an additional burden of from 20,000 crores 30,000 crores.
The Finance Minister recently wondered why private sector investment is not happening in a big way. This risk aversion or caution could be due to concerns of a global slowdown and a lack of conviction in sustainable demand that could justify capacity expansion in manufacturing. The central bank itself has revised its development approach downward and so have many other agencies. The episode in the UK following its mini-budget, or as with any jolts in geopolitical tensions, finds increasing mentions with the “nuclear option” at levels that should concern us, even the bravest and most Can take wind from even the toughest optimists.
India ranks well in terms of its growth-inflation dynamics, but the country’s trade or investment cycle is unlikely to bounce high in the near future. Even though the current signs of liquidity crisis want you to think otherwise.
Ajit Ranade is an economist from Pune.
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