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Informist, Wednesday, Feb. 5, 2025

 

By Siddharth Upasani

 

NEW DELHI – After a reduction in the cash reserve ratio in December and a raft of measures in January that will pump in about INR 1.5 trillion of liquidity by the third week of February, all eyes are on what action the Reserve Bank of India may announce on Friday to further ease liquidity conditions. The importance of cooling the liquidity strain has even been recognised by New Delhi, with the Union Budget for 2025-26 (Apr-Mar) estimating its total recourse to the Ways and Means Advances in FY26 at INR 5 trillion.

 

According to Economic Affairs Secretary Ajay Seth, the sharp increase in the figure for next year from INR 550 billion in the current year is part of the Centre's aim to be lean when it comes to the cash position, which has complicated the RBI's ability to manage liquidity conditions. There is, however, only so much Seth can do.

 

A key driver of the Centre's cash position is that of states, with the surplus they hold automatically invested in 14-day intermediate treasury bills. And the sums invested in this instrument have risen over the years from INR 862 billion at the end of FY14 to INR 2.67 trillion at the end of FY24. This is despite the cost to states: in FY21, the negative carry for states was as high as 520 basis points, representing the difference between their average cost of borrowing of 6.55% that year and the interest rate of 1.35% they earned on these bills.

 

The build-up of states' cash holdings has occurred even though the negative carry rose sharply after the rate of interest on the 14-day T-bills was slashed from a fixed 5% to the reverse repo rate minus 200 bps in January 2017.

 

MANAGING THE SURPLUS

For the Centre, the room to manage its cash balances is seemingly limited; after all, it can't reject revenue inflows from taxes and other sources. On the expenditure front, the rollout of the just-in-time system has eliminated the float in banks' accounts. While this helps reduce the Centre's interest burden, it also reduces systemic liquidity.

 

On the borrowing side, frequent changes to the bond auction calendar in response to build-up or drawdown in cash balance may not be practical. However, it is easier when it comes T-bills and the Centre has done just that recently, cancelling these auctions when it could. This is reflected in the revised estimate of (-)INR 1.20 trillion for net short-term borrowings in FY25 from (-)INR 500.00 billion estimated in February last year. For FY26, the Centre's net short-term borrowings are seen at nil.

 

If the Centre still ends up with cash well in excess of its needs, it could retire some of its debt early through buybacks, as it has done to good effect this year.

 

Management of states' cash position has proved to be more difficult, with years of concerns not bearing fruit. "...states need to make efforts towards better expenditure management and cash forecasting for effective cash management," the RBI had said in its annual report for 2017-18 (Jul-Jun).

 

Unlike the Centre, states don't issue T-bills to finance their deficits. As such, they keep cash buffers to meet unexpected outflows, with these balances automatically invested in the 14-day T-bills due to non-availability of other short-term investment avenues.

 

States also can't afford to tinker much with their own borrowing programme as the market's appetite for their securities is not the same as it is for the Centre's. This results in states borrowing even as they are sitting on large cash balances. On the revenue side, tax devolution from the Centre, while predictable in terms of timing, is chunky.

 

According to ICICI Securities Primary Dealership, it might be a "good opportunity for government and RBI to put in place a system where states are encouraged to use the banking system to park durable surpluses". Market players have made similar noises earlier, with Nilesh Shah, managing director at Kotak Mahindra Asset Management and part-time member of the Economic Advisory Council to the Prime Minister, saying last year that banks' deposit growth and liquidity deficit issues could be eased if the government kept its cash balances with commercial banks in the form of short-term deposits.

 

Bridging the prevailing huge liquidity deficit requires the RBI to constantly conduct fine-tuning operations such as variable rate repos. And if it thinks these deficits are more permanent in nature, it injects durable liquidity through open market purchases or a reduction in the cash reserve ratio. While these assessments are easier when it is the RBI's own actions that create the deficit--or surplus--as has been the case with its massive dollar sales to shore up the rupee, it can often be stuck wondering when the source of the liquidity deficit is numerous regional governments. An effective resolution would have to go beyond the Centre maintaining a lean wallet.  End

 

US$1 = INR 87.46

 

Edited by Avishek Dutta

 

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