Excess liquidity in the banking system back to pre-Covid levels

India’s banking system liquidity is likely to reach pre-pandemic levels by the end of this financial year as the central bank embarks on an aggressive liquidity withdrawal strategy to tame inflationary pressures, bankers and economists say.

On May 4, the Reserve Bank of India increased the rate at which it lends short-term funds to commercial banks by 40 basis points to 4.4 percent and upped the Cash Reserve Ratio (CRR), the portion of deposits that banks must hold in liquid cash, by 50 basis points to 4.5 percent. One basis point is one-hundredth of a percentage point.

The CRR increase, effective the fortnight of May 21, means that banks will have a relatively low lending capacity in terms of funds and so would raise interest rates on deposits to raise funds. The CRR hike is expected to withdraw liquidity to the tune of around Rs. 87,000 crore.

“The RBI is adopting a simple rationale that in order to normalise rates, liquidity withdrawal is needed, that too in large chunks. It is a clear sign that the RBI is worried about inflation,” said Abhishek Upadhyay, senior economist at ICICI Primary Dealership.