Liquidity conditions in the money market are alarming. The system’s liquidity, as measured by bids for repo through the Reserve Bank of India’s (RBI’s) liquidity adjustment facility (LAF), stood at over Rs 150,000 crore on 17 and 18 January 2012.
The repo is the rate at which the RBI lends funds to banks and the demand for funds from it has gone up from Rs 80,000 crore around end-September 2011 to Rs 155,000 crore as of 18 January 2012. Liquidity has tightened by Rs 75,000 crore over the last three-and-a-half months.
The tightness is despite the infusion of primary liquidity by the RBI through government bond purchases and by lending to the government through overdrafts. The RBI has bought bonds worth Rs 61,000 crore over the last two months through OMO (open market operations) purchase auctions. The government has drawn down Rs 49,420 crores as of 6 January from the WMA (ways and means advances) window of the RBI.
RBI buying of bonds and government running an overdraft is tantamount to addition of funds into the system and a total of Rs 110,000 crore has been infused into the system over the last two months.
Where has all the money gone? The system is borrowing over Rs 150,000 crore from the RBI on a daily basis, which is higher by Rs 75,000 crore since end-September 2011 despite an addition of Rs 110,000 crore of primary liquidity. The total leakage of liquidity since end-September 2011 to date is Rs 185,000 crore.
Breaking down a few liquidity driving factors in the September-December 2011 period, Rs 51,000 crore can be accounted for by a rise in notes in circulation and Rs 29,000 crore can be accounted for by the difference between aggregate credit and deposit figures – ie, banks have given out more credit than they have collected as deposits. Leakage of currency and the difference between credit and deposits account for Rs 80,000 crore of liquidity outflow.
The other factors that have affected liquidity include the RBI selling of US dollars in the currency markets. The RBI’s sales figures, as of November 2011, are around USD 2.9 billion as per CCIL (Clearing Corporation of India) data. The RBI is seen to be selling more USD in the last couple of weeks and this selling has driven up the rupee from Rs 53.25 to Rs 51.
RBI currency intervention could have affected liquidity by Rs 40,000 crore (assuming RBI has sold a total of USD 8 billion in the market). Its intervention, coupled with currency leakage and credit and deposit difference, account for Rs 120,000 crore of liquidity going out of the system.
The rest of the liquidity outflow - Rs 1,85,000 crore less Rs 120,000 crore, which is Rs 65,000 crore – cannot be accounted for by data available. It does look like a case of liquidity becoming structurally deficient with leakages across the system, part accounted and part unaccounted.
The RBI has a lot of work to do on liquidity management given the current liquidity tightness, which is becoming alarming. It has to communicate its analysis on liquidity to the market, as a market that is befuddled by liquidity will push up money market rates.
One-year bank CDs (certificate of deposits) have shot up by 30bps (100 bps make 1 percent) over the last 15 days and the rates are looking to trend higher from current levels of 9.95 percent. A market unclear on liquidity will rush to mop up any available liquidity at any cost, leading to a sharp rise in rates across.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.