With the new government set to take charge soon, banks expect liquidity to ease from mid-month due to increased government spending. Last month, the banking system faced a severe liquidity deficit caused by reduced government spending and GST outflows.
To relieve cash-starved banks, the Reserve Bank of India (RBI) injected nearly 9 trillion into the banking system through 11 Variable Rate Repo (VRR) auctions in May, the highest this calendar year.
“Government spending was stalled due to the model code of conduct imposed during the general elections. Now that the elections are over, government spending is set to increase once the new government takes charge,” V Ramachandra Reddy, head of treasury at Karur Vysya Bank, told FE. “The days of huge liquidity deficits for banks are over,” he added.
He anticipates government spending to gain momentum from the second week of this month. Facing tight liquidity, banks desperately placed bids worth 13.54 trillion against a total notified amount of 9 trillion in 11 VRRs conducted in May. Last month, the liquidity deficit rose to 2.32 trillion but improved slightly by month-end, declining to 1.38 trillion on May 28.
“Banks were short of funds due to increased cash circulation from election-related spending by political parties. With the elections over, cash in circulation will decrease and return to the banks,” said the head of retail banking at a private sector bank.
Earlier, the banking system experienced a cash squeeze in February. To address this, the central bank conducted seven VRRs, infusing 7.5 trillion into the banking system. April was relatively easier, with occasional liquidity surpluses providing relief to banks. A repo auction is conducted by the central bank to inject liquidity into the system, and banks can obtain overnight liquidity through RBI’s marginal standing facility when interbank liquidity dries up.