Excessive Liquidity Can Pose Risks To Price, Financial Stability: RBI Governor

The Reserve Bank of India opted to keep the policy rate unchanged at 6.5% for fourth consecutive time as it seeks to keep a tight watch on inflation. RBI Governor Shaktikanta Das said India is poised to be the new growth engine of the world.

"Liquidity distribution in banking system skewed. Excessive liquidity can pose risks to price and financial stability. Moderation in excess liquidity led to more recourse to marginal standing facility," said RBI Governor. Experts feel that RBI may keep liquidity conditions tight and may announce liquidity injection measures if liquidity deficit widens during the festival season.

The RBI Governor said that the pitch is turning and we will play the ball on merit. Today's policy is like Kapil Dev Policy. It will manage liquidity, inflation, growth, rupee and financial sector stability in an appropriate equilibrium like a legendary all-rounder Kapil Dev managed bowling, batting, fielding and captain ship.

The RBI has worked hard to create a balance between growth and inflation setting an example for rest of the world. This policy continues to take that hard work forward, added Das.

Ms. Achala Jethmalani, Economist at RBL Bank said, "In line with our expectations, the MPC maintained a status-quo on policy rates and stance. We view it as a 'hawkish hold' on policy rates as the focus remains on bringing inflation down to the 4.0% target. The RBI's comments on existing banking system liquidity is indicative of tighter system liquidity conditions continuing as it stands ready to deploy all its tools to absorb excess system liquidity. Brace for a long pause on the Repo Rate with tighter liquidity conditions. This is expected to complete the policy transmission in this hiking cycle with the objective of keeping borrowing costs high. The resilience in economic growth despite the restrictive financial conditions underpin the RBI's move to tighten the liquidity conditions."

Liquidity in the banking systems stayed tight in last couple of days after the advance tax payments and goods and service tax payments despite the reversal of I-CRR.

Before this liquidity stayed in massive surplus and in order to handle this, RBI on August 10 urged the scheduled banks to maintain an I-CRR of 10% on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28.

RBI on September 8, 2023 decided to halt the the I-CRR in a phased manner, after the review. Central bank on the same day said that 25% of the funds maintained in the I-CRR would be released on September 9 and 25% on September 23 while remaining 50% would be released on October 7.

Liquidity in banking system began to decline in the deficit zone after September 15 despite the fact that I-CRR was reversed twice.

According to the data of Reserve Bank of India (RBI), systemic liquidity fell into a deficit on September 15 and widened to more than Rs 1 lakh crore on September 18.

Generally, banks would need to borrow funds from the central bank to meet their reserve requirement, if it cannot be met from the inter-bank market and vice-versa, i.e. deposit the excess over the reserve requirement with the central bank.

On a given day, if the banking system is a net borrower from the Reserve Bank under LAF, the system liquidity can be said to be in deficit (i.e., system demand for borrowed reserves is positive) and if the banking system is a net lender to the Reserve Bank, the system liquidity can be said to be in surplus (i.e., system demand for borrowed reserves is negative).