Liquidity appears to be quite mismatched at present. The banking system is dealing with high credit growth, funding the same through Certificates of Deposit (CDs), with some banks resorting to deposit rate hikes, even as rate cut(s) are anticipated in the second half of this year.
In contrast, the government seems to be experiencing much more comfortable liquidity conditions, possibly linked to slower spending amidst the Model Code of Conduct and the Parliamentary elections.
The systemic liquidity deficit has averaged at ₹1.3 trillion (0.6 per cent of NDTL) during April 20-May 21, 2024, in contrast with the surplus seen during the April 1-19, 2024. Notably, the Union government’s cash balances had surged from ₹1.1 trillion as on April 5, 2024, to ₹1.5 trillion by April 19, 2024.
High balances
Thereafter, sizeable GST collections along with weak spending momentum pushed the Centre’s cash balances further to ₹2.4 trillion by May 3, 2024, significantly higher than cash balances of ₹97 billion as on May 3, 2023.
The government’s ample cash position appears to be the trigger for two recent developments: a cutback in its planned gross Treasury bill issuances for Q1 FY2025 by ₹600 billion and announcements of three rounds of buybacks of Government of India securities (G-sec) worth ₹1.6 trillion.
Interestingly, the total accepted amount across the three auctions in May 2024 was limited to ₹178.5 billion, just 11.2 per cent of the notified amount.
The buyback of G-secs in May 2024 was expected to dampen G-sec yields. This, along with the reduction in the planned gross T-bill issuances, was anticipated to rein in short-term rates, by easing systemic liquidity. Although G-sec yields did decline post these announcements, liquidity remains stretched.
The government’s cash balances are likely to have increased further through May 2024. Moreover, the RBI announced an unexpectedly large dividend transfer to the government, of ₹2.1 trillion. This amount is well above the ₹1.5 trillion budgeted under dividends and profits, which includes dividends from PSUs.
This windfall is likely to provide additional leeway of ₹1.0 trillion to the government for enhanced expenditures or a sharper fiscal consolidation than what was pencilled in the Interim Budget for FY2025.
A smaller fiscal deficit target would likely imply lower G-sec issuances in H2 FY2025, compared to what was anticipated after the Interim Budget for FY2025 was presented.
Given this, and the typical quarter-end tax inflows along with the expectations that the government spending will remain sluggish until the full budget in July 2024, systemic liquidity conditions are expected to remain tight through the next month. This implies that the central bank would continue to conduct Variable Rate Repos (VRR) in the near term.
The RBI has conducted eight VRRs so far in May 2024, with tenures ranging from overnight to 14 days, cumulatively pumping in ₹6.3 trillion via this route in the month. Interestingly, banks have preferred the VRR route to garner liquidity support, as against the buyback route.
Dividend transfer
Following the announcement of the larger-than-expected dividend transfer by the RBI, the yield on the new 10-year G-sec dipped to 7.0 per cent on May 22, 2024 from the previous day’s closing of 7.04 per cent. ICRA expects the 10-year G-sec yield to ease further below the 7.0 per cent mark in the run up to the inclusion of Indian Government Bonds in the JP Morgan Government Bond Index-Emerging Markets, amid the possibility of a cut in the budgeted market borrowings for FY2025.
Looking ahead, ICRA expects the 10-year G-sec yield to trade between 6.80-7.15 per cent in the remainder of H1 FY2025. Yields may harden close to the upper limit of this range, if the expectations about the timing of rate cuts by the US Federal Reserve and the RBI’s Monetary Policy Committee (MPC) are pushed out beyond Q3 FY2025.
The upcoming MPC review in June is expected to deliver a status quo on the rates and the stance. However, the market participants would await cues on how the RBI intends to address the systemic liquidity situation over the next few months.
The writer is Chief Economist, Head- Research & Outreach, ICRA