Government Overdraft Leads to Surging Liquidity - Jan 2020

Government is borrowing money from RBI for its spending and this is leading to surging system liquidity. RBI has already issued Rs 900 billion of Cash Management Bills to bring down the overdraft and may require to issues more bills given the extremely weak state of government finances.

RBI continues to buy USD in November leading to rise in system liquidity.

RBI net outstanding forward sales were USD 6.14 billion as of November 2019, as against net forward sales outstanding of USD 7.47 billion in October 2019, RBI bought USD 1.33 billion of forwards to net off the sales position.RBI net bought USD 6.92 billion in the spot market in November, infusing Rs 491.42 billion of liquidity into the system.

System liquidity rose by around Rs 672 billion months on month and was at a surplus of Rs 3775 billion as of 12th January 2020. Cash management bills (CMB) outstanding was at Rs 900 billion. Currency in circulation declined by Rs 160.40 billion in December 2019.In December-January RBI bought Rs 300 billion bonds and sold Rs 253.26 billion bonds through Special Open Market Operation called operation twist.

The ICDR as of 20th December 2019 was 55.31%, credit grew by Rs 6595.67 billion, year on year, while deposits grew by Rs 11923.78 billion. Banks have to maintain CRR of 4% and SLR of 18.25%, and ideal ICDR for liquidity neutrality for banks is around 75%.

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), Long Term Repo Operations (LTROs)/Targeted Long-Term Repos Operations (TLTROs) 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 April 2020 is 3% 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 increases due to inflation.

RBI purchasing USD adds INR liquidity while USD sales lower 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. 15^th 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.

Liquidity Operations (In INR Billions)