Goldman Sachs in a report titled Asia Economics Analyst: Changing dynamics of banking system liquidity in India, expected the liquidity conditions to ease on drawdown of cash balances and rising government expenditure going forward.
We expect some intermittent tightness due to tax outflows by mid-March, which is likely to correct by April. This, however, may not necessarily ease the Weighted Average Credit Rating (WACR) – repo spread, it said.
In recent months, banking system liquidity conditions have largely been driven by the movements in the government’s cash balance with the RBI, a temporary driver of liquidity.
Liquidity conditions eased significantly in the first week of February after the announcement of the Interim Budget easing short-term rates.
Further, the liquidity conditions tightened again with a build-up of government cash balance from the second week of February.
Demand for larger liquidity surpluses to narrow WACR-repo spread
Citing its analysis, Goldman Sachs said that banks are unwilling to trade among themselves in the inter-bank market.
“In our view, banks need to be incentivized to trade among themselves rather than with the RBI because the monetary policy transmission process depends on the inter-bank market working effectively,” it said.
It further highlighted that there is a skew in the banking system liquidity where banks are simultaneously depositing with the RBI at the SDF and borrowing from the RBI at the MSF, likely due to uncertainty in liquidity management among banks.
It suggested measures that can potentially ease the skew such as shorter tenor variable-rate repo/reverse repo to supplement the 14-day variable rate repo/reverse repo main operation to manage daily liquidity requirements.
Extended money market timings may help banks meet demands of 24×7 banking. This would also help in bringing down CD rates for banks and other short-term rates for non-bank entities.
Need to look at alternative measures to counter frictional liquidity shocks
Goldman Sachs further highlighted that with the WACR exceeding the repo rate due to extended periods of large government cash balances in recent years, policymakers may need to look at alternative measures to counter frictional liquidity shocks
Finally, with the call rate exceeding the repo consistently due to extended periods of large government cash balances, policymakers may need to look at alternative measures to counter large and persistent liquidity shocks.
These can potentially include longer-term repo operations when government cash balances build-up, and spreading out government borrowing to smooth cash holdings.
