With the July retail inflation easing to a five-year low of 3.54 per cent and the first quarter GDP growth decelerating to a five-quarter low of 6.7 per cent, the RBI is focusing on maintaining adequate liquidity in the banking system. This approach is aimed at balancing its dual objectives of steering inflation towards a sustainable 4 per cent and supporting economic growth, according to market experts.
In his bi-monthly monetary policy statement last month, RBI Governor Shaktikanta Das cautioned that the expected moderation in headline (retail) inflation during the second quarter of 2024-25, on account of favourable base effects, is likely to reverse in the third quarter.
Domestic growth, however, is holding steady, supported by consistent urban consumption, improving rural consumption, and strong investment demand.
The current moderate surplus in the banking system will ensure that it does not stoke inflation and dampen credit growth, opined the experts.
Liquidity in the banking system has been in the surplus range of ₹1 lakh crore – ₹1.50 lakh crore over the last couple of months due to stepped up government spending, post general elections, leading the central bank to employ liquidity draining measures via the variable rate reverse repo (VRRR) auctions.
The VRRR auctions align with the monetary policy committee’s “withdrawal of accommodation” stance. In August, the RBI conducted 19 VRRR auctions to withdraw liquidity from the banking system.
“The RBI is actively managing liquidity in a bid to maintain inflation at or below 4 per cent on a sustainable basis. In August 2024, the RBI successfully brought down system liquidity to around ₹1 lakh crore, underscoring its commitment to this target.
“This is evidenced by the increased frequency of VRRR operations conducted by the RBI during the month,” said Venkatakrishnan Srinivasan, Founder and Managing Partner, Rockfort Fincap LLP.
Retail inflation, measured by the Consumer Price Index (CPI), declined to a 5-year low of 3.54 per cent in July 2024 after accelerating to a four-month high of 5.08 per cent in June 2024. The first quarter GDP growth decelerated to a five quarter low of 6.7 per cent against 8.2 per cent in the year ago quarter.
Ashima Goyal, Emeritus Professor, IGIDR, Mumbai, in her statement at the August 2024 monetary policy committee meeting, observed that credit eventually creates deposits through rising incomes and savings, but in the meanwhile banks should maintain adequate liquidity buffers.
“We are seeing market rates coming down as liquidity improves with government spending. The call money rate is also near the repo rate (6.50 per cent). This should be maintained,” Goyal added.
“Adequate liquidity is required along with prudential policies that create good incentives for the financial sector, especially since the sources of liquidity are limited for many parts of India’s financial sector leading to liquidity hoarding. Balance requires that over-strictness is avoided,” Goyal said.
RBI’s staffers, in their latest monthly study on the “State of the Economy” noted that system liquidity remained in surplus during July and August so far on the back of increase in government spending, return of currency to the banking system and the Reserve Bank’s forex operations.