Banking may continue to face liquidity crunch

The liquidity crunch faced by the banking system may not see respite for the rest of this fiscal.

According to experts, even if the government spends all of its surplus cash, the banking system will continue to remain in the deficit mode.

“Without further liquidity easing measures, even if the government spends all of its surplus cash, the banking system liquidity will remain in deficit at end-March 2011,” said Samiran Chakraborty and Nagaraj Kulkarni of Standard Chartered Bank in a report released on Thursday.

Chakraborty and Kulkarni explain this argument under two scenarios. According to the first scenario the fiscal deficit is assumed to be 5% of the gross domestic product (GDP).

This can be achieved if the government limits FY11 expenditure to Rs12.2 lakh crore against a budgeted Rs11.1 lakh crore. This means that the government would spend only Rs4.7 lakh crore between December 2010 and March 2011, despite its current high cash balance and supplementary spending plans announced after the budget. As a result of limited government expenditure and other cash flows from the banking system, Chakraborty and Kulkarni estimate the March-end 2011 liquidity deficit at Rs75,000 crore under this scenario, and the government cash surplus at a healthy Rs30,000 crore.

In the second scenario, the fiscal deficit is assumed to be 5.5% of GDP.

“For this to happen, the government would have to spend a total of Rs12.6 lakh crore during FY11, implying spending of Rs5 lakh crore between December 2010 and March 2011. After accounting for other banking-system cash flows, we estimate the end-March 2011 liquidity deficit at about Rs50,000 crore under this scenario, and the government cash surplus at a marginally positive level,” said Chakraborty and Kulkarni.

This means the government needs to think beyond spending surplus cash.

“It is not possible for the RBI (Reserve Bank of India) to do a cash reserve ratio (CRR) cut, because they are still worried about inflation. So maybe the RBI should do more OMO (open market operations) purchases of gilts,” said A Prasanna, economist and vice-president, ICICI Securities-Primary Dealership.

In the OMO purchase auction held on Thursday, the RBI accepted Rs10,120 crore of the `12,000 crore announced. “OMO purchases help in infusing liquidity and I feel the RBI should do one OMO purchase per fortnight,” said Prasanna Patankar, senior vice president at STCI Primary Dealer.

On Thursday, banks borrowed Rs1,22,980 crore from the RBI under daily liquidity
adjustment facility. In the last one month, the banking system had borrowed an average of Rs1,04,809 crore on a daily basis, compared with an average of Rs59,346 crore in April.