Banks have been borrowing over Rs1 lakh crore every day from the Reserve Bank of India (RBI) for over two weeks, primarily because customers have withdrawn significantly large amounts of cash in the festive season.
“The increase in currency with public has been higher than expected in this festive season and government cash balance is high too,” said RBI deputy governor H R Khan.
The more the government spends -- instead of keeping cash -- the more is the liquidity since the funds flow through the banking system.
To be sure, currency in circulation (comprising those with public and cash in hand) showed an increase of 13.6% on November 16, 2012 over last year.
In absolute terms, currency with public stood at Rs10.65 lakh crore on November 2, the latest date for which data is available.
Khan said the central bank is constantly monitoring the liquidity conditions. “If it is short term, it will pass on. If it is long term, we will take necessary action,” he said.
The markets are expecting that the RBI will conduct open market operations (OMOs) to purchase government bonds and infuse liquidity.
Khan, however, maintained that the decision on OMOs will be taken as and when required. The central bank has not resorted to OMOs in the second half of financial year so far.
The RBI had reduced the cash reserve ratio by 25 basis points to 4.25% effective the fortnight beginning November 3, 2012. The step was taken in anticipation of tighter liquidity conditions during the festive season, said RBI in the second quarter review of the monetary and credit policy.
Cash reserve ratio is the amount banks need to keep with the regulator on a fortnightly basis. Banks borrow from the RBI’s LAF at the repo rate in order to meet the reserve requirements during tighter liquidity conditions.
Despite the reduction in cash reserve ratio, liquidity deficit has been higher than the RBI’s comfort zone of 1% net demand and time liabilities for most of the period after the reduction.
Also, retail credit disbursements by banks shoot up during the third quarter on account of high demand for home and auto loans.
This results in banks borrowing higher from the money market in the form of overnight funds and certificates of deposits. The overnight call money rate touched a high of 8.15% on Monday and three-month certificate of deposits were being issued at around 8.5%. The repo rate at which banks borrow from RBI is at 8%.