India: Surplus liquidity to stay but demand needs to revive

October 22, 2020

NEW DELHI - The level of surplus liquidity in India has hovered above INR4 trillion on a durable basis since the start of the year, touching INR8 trillion in May -- and continues at what ANZ Bank describes as a "generous" INR5.5 trillion, or 2.7% of GDP.

"Various policy tools have cumulatively added to this surplus in the system, the chief one being the RBI's strong FX intervention and liquidity-enhancing measures since the pandemic struck in March," ANZ says in a research report.

"The RBI has intervened to the tune of US$50 billion in the spot market alone year-to-date, directly adding to liquidity pressures in the system," it says.

"In addition, the RBI has undertaken a slew of liquidity-enhancing measures, including the stepped up Open Market Operations and a 1% reduction in the Cash Reserve Ratio (CRR)."

But ANZ says that while banks are flush with liquidity, there is risk aversion in lending..

"The current environment of soft credit growth and ample liquidity will likely see this trend continue, especially amid increased borrowings, both by central and state governments," the report says.

"The simultaneous increase in deposit growth, in addition to weak credit off-take, is adding to surplus liquidity in the system.

"Credit growth in almost all sectors and types of borrowers remains tepid, and is unlikely to improve unless expected returns on investment improve."

The report says the combination of weak credit off-take and high deposits has pushed the loan-to-deposit ratio to multi-year lows, and that this is a concern given that the economy needs an upturn in the credit cycle to kick-start capex growth and investment recovery.

It warns that while the need for surplus liquidity conditions during a recession has few dissenters, policymakers must ensure that easy conditions are subsequently met by improving underlying demand, which in India continues to be "fairly subdued".

"Capacity utilisation rates are picking up but slowly," ANZ says. "Demand indicators across a spectrum of data are showing signs of revival but still have a long way to go.

"A sustained improvement would require stronger demand augmenting measures including robust jobs growth.

"We are also of the view that a shift towards a neutral liquidity stance will likely be effected only when 1) economic recovery gains momentum; 2) government spending slows in order to bridge the fiscal deficit; 3) FX intervention is eased owing to associated costs; and 4) economic recovery coupled with increasing capacity utilisation could stoke inflationary pressures.

"Till then, we will continue to see the RBI bat for an accommodative monetary policy stance, which will include a reliance on liquidity managing and enhancing tools. (ATI)