Rising economic uncertainties forced people to hoard more cash in the first four months of the calendar than they had done in the entire 2019, data released by the Reserve Bank of India (RBI) shows.
The increase in currency in circulation between January and May 1 was Rs 2.66 trillion. In comparison, it increased by Rs 2.40 trillion in the entire 2019 (January to December).
The rise in currency in circulation (CIC) is perplexing when economic activities have nosedived. Generally, CIC should rise in tandem with the growth in economic activities, as people need cash to transact. The demand for currencies also generally spikes during the festive season, and during elections.
However, the increase in CIC without any such events, and that too when economic activities have shrunk, means people are withdrawing a large amount of cash and keeping it with them, instead of depositing it with banks.
Banks had parked Rs 8.53 trillion of their excess liquidity with the central bank as of Tuesday, data showed. It is so because banks don’t want to lend and find it convenient to keep their surplus money with the RBI, earning just 3.75 per cent interest. Now, if the lockdown is lifted and the economy starts to function normally, people will want to use their cash, and likely deposit them back.
This will push up the banking system liquidity even further. Banks are unlikely to start lending, and companies themselves also won’t want to increase their debt when there is huge excess capacity lying unutilised.
Some of the large surpluses that banks are parking with the central bank has also been caused by the long-term repo operations (LTRO) undertaken by the central bank between February and March this year. The central bank had infused about Rs 1.25 trillion through the original LTRO.
“Amid unusual condition, the RBI can allow banks to repay back the money by providing Call option for the regular LTRO auction conducted between February and March 15. This will reduce pressure on the RBI to sterilise money through reverse repo by providing securities. And in case demand for credit improves, banks can still borrow from LTRO,” said Soumyajit Niyogi, associate director at India Ratings and Research.
That could address some of the concerns for sure, but banks will still have a huge liquidity surplus to park. However, the central bank may not have adequate bonds to support this kind of liquidity operation, considering it has about Rs 9-10 trillion worth of bonds in its books, of which about Rs 2 trillion it generally maintains as a buffer.
This may force the central bank to also come up with additional policy measures that would prevent banks from sitting idle on their cash.
It can cap how much banks can keep their money in the reverse repo window. Or it can introduce a standing deposit facility (SDF) under which the RBI can accept as many surplus funds banks have to offer, but at a rate lower than the reverse repo rate (which is currently at 3.75 per cent). The RBI can use both the reverse repo cap and also the SDF. And it can also charge banks for keeping money with the central bank, say, economists.
But economists also say that banks will still not lend as long as the government doesn’t come up with a stimulus package.
“Bankers are possibly also scared about what will happen to them after the loans go sour. There is a complete risk aversion unless the government instructs banks to do some targeted lending,” said a senior economist.