The Reserve Bank of India (RBI) is actively implementing measures to address the liquidity deficit in the banking system, raising questions about whether these actions signal a gradual shift toward easing its monetary stance.
The RBI’s actions come at a time when global dynamics are shifting, with the INR under pressure and the dollar showing signs of weakness.
“The fluidity of global dynamics would be playing an important role in the RBI’s conventional rate cuts, especially with INR pressures mounting. Thus, steps for liquidity management and unconventional measures, specifically gradual easing of regulatory lending norms to re-spur waning credit offtake, etc, would probably play an important role in easing the RBI stance by stealth and consequently the lending conditions in the economy,” Emkay Global Financial Services said in a report.
Analysts also speculate that the RBI may even cut rates in February 2025, although this will depend on how the liquidity situation evolves and the broader economic context.
“The recent dollar weakness has given some breathing space to EMFX (and INR), which could also provide some wiggle room to the RBI on its monetary reaction function. And for any cuts to be effective on transmission, a better banking system liquidity is pertinent,” the Emkay Global report said.
As of January 23, 2025, the liquidity deficit in the banking system stood at a record Rs 3.34 lakh crore, the highest ever recorded. The deficit was primarily driven by factors such as lower government spending, sluggish deposit growth, and the outflow of taxes. The RBI’s recent actions, aimed at improving liquidity, could hint at a subtle easing of its policy, analysts said.
The RBI measures
To mitigate the liquidity crunch, the RBI has announced the purchase of government securities worth Rs 60,000 crore through Open Market Operations (OMO). These purchases will be conducted in three tranches, with the first tranche scheduled for January 30, 2025, followed by February 13 and February 20, 2025.
This strategy is expected to inject much-needed liquidity into the financial system, though it raises questions about how effective the liquidity infusion will be, given that banks are already operating near their minimum liquidity coverage ratios. The success of the OMOs will depend largely on banks’ ability to offer surplus government securities to the RBI.
Additionally, the RBI will conduct a USD/INR Buy/Sell Swap Auction on January 31, 2025, for $5 billion with a six-month tenor. This auction is designed to stabilize the Indian Rupee (INR) amid rising pressures in the foreign exchange market. Analysts suggest this move is aimed at smoothing out the impact of a maturing short position in the forward market and preventing further downward pressure on the INR, which has been a concern in recent months.
In another move to enhance liquidity, the RBI is set to conduct a 56-day Variable Rate Repo Auction worth Rs 50,000 crore on February 7, 2025. This measure is designed to inject durable liquidity into the system, with a focus on maintaining long-term market stability.
The impact
Despite these measures, the impact on the banking sector may be limited. While the OMOs will provide liquidity to the market, they are unlikely to have a direct impact on banking system liquidity unless bondholders convert the cash into bank deposits.
Moreover, the OMOs could lead to a sharp decline in government bond yields, which benefits only highly-rated corporates and government bonds, while sectors like SMEs, MSMEs, and retail borrowers, which rely heavily on bank loans, may see little change in their cost of funds.
For investors, the RBI’s liquidity measures could create a more favourable environment for equities. With increased liquidity, banks may be more inclined to extend credit, potentially boosting business activity and corporate earnings, which in turn could support growth in the stock market. Furthermore, the potential for lower interest rates, if the RBI cuts the repo rate in the upcoming policy review, could make equities more attractive compared to fixed-income investments.