12 Dec 2016

Liquidity to Stay in High Surplus till March 2017 - Liquidity Cheat Sheet December 2016

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Government’s move to demonetise Rs 500 and Rs 1000 notes has resulted in a surge in liquidity with currency in circulation falling sharply and coming back into the banking system in the form of deposits.

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Arjun Parthasarathy

Government’s move to demonetise Rs 500 and Rs 1000 notes has resulted in a surge in liquidity with currency in circulation falling sharply and coming back into the banking system in the form of deposits. High liquidity surplus will continue till March 2017 as the system will take few more months to normalise.

Liquidity as of 12th December was in surplus of Rs 5164 billion against deficit of  Rs 155 billion  as of 12th November 2016.Inflow of Rs 7200 billion as currency in circulation dropped on demonetisation led to rise in liquidity. FCNR B deposits of around USD 17 billion in November did not show up in liquidity due to demoentisation effects.

Government has issued Rs 3600 billion of Cash Management Bills as part of its MSS to sterilize system liquidity.

RBI fx operations were muted in October with almost nil net purchase or sale. On a cumulative basis, RBI has bought USD 10.7 billion in the April-September 2016 period, infusing Rs 701 billion into the system. RBI outstanding forward purchase contracts was at USD 5.6 billion in October from USD 4.9 billion in September.

Liquidity Cheat Sheet

The Liquidity Cheat Sheet is for assessing system liquidity and the drivers of system liquidity.

System liquidity is defined as bids for Repo, Reverse Repo and Term Repo/Reverse Repo LAF (Liquidity Adjustment Facility) auctions held by the RBI. Drawdowns from MSF and Export Credit Refinance Facility are the other constituents of system liquidity.

The need for liquidity is largely driven by the requirement to maintain CRR (Cash Reserve Ratio) balances with the RBI. CRR as of May 2016 is 4% of NDTL (Net Demand and Time Liabilities). Deficit system liquidity suggests that banks require to borrow from RBI to maintain CRR balances while surplus liquidity suggests that banks have excess funds over and above maintaining CRR balances.

The drivers of system liquidity include Currency in Circulation (outflows), RBI fx purchase (inflows)/ sales (outflows), RBI OMO sales (outflows)/purchase (inflows) and government surplus (outflows)/ deficit (inflows).

Currency in Circulation is money going out of banking system and being held as cash by the public. For example if you draw cash from an ATM, money goes out as cash. Currency in Circulation is determined by need to hold cash for transactions and cash held as black money. Inflation affects need to hold cash as value of goods and services increase due to inflation.

RBI purchasing USD adds INR liquidity while USD sales lowers INR liquidity as the central bank pays or receives INR for buying/selling USD.

RBI selling bonds through OMO takes out liquidity as markets pays RBI for buying bonds while bond purchases through OMO infuses liquidity as RBI pays the market for buying bonds. Maturity of RBI forward sale/purchase contracts also affect system liquidity.

Government surplus is money kept with the RBI while government deficit is money borrowed from the RBI. Government surplus is liquidity negative as money goes out of banking system into government account with RBI. Government deficit is liquidity positive as RBI lends money to government through WMA (Ways and Means Advances) facility. Government spends money by drawing down on WMA and that adds to banking system liquidity.

Others include IPO inflows that add to bank deposits, spectrum and other license auctions that add to government cash balances and MSS (Market Stabilization Scheme) that takes out liquidity from system as market pays for purchasing MSS bonds.

Advance tax payments goes out of banking system into government account with the RBI every quarter i.e. 15th of June, September, December and March.

Government bonds that mature and come up for redemption adds to banking system liquidity as money goes from government to holders of the bonds.

Government pays interest of around Rs 4000 billion every year and that adds to system liquidity.



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