The Indian banking system recently reported an increase in its liquidity to Rs 2.59 lakh crore on June 4, 2023. Despite these positive figures, estimates suggest that surplus liquidity will decrease to about Rs 1.5 lakh crore in the following days from the current level of Rs 2.1 lakh crore. The net liquidity in the banking system indicates the amount of money absorbed by the Reserve Bank of India (RBI) from the system.
Understanding surplus liquidity
Surplus liquidity occurs when cash inflows into the banking system persistently exceed withdrawals of liquidity from the market by the central bank. In other words, it’s the readily accessible cash that banks need to meet short-term business and financial needs.
What drives increased liquidity?
Several factors lead to increased liquidity in the Indian banking system. These include advance tax and goods and services tax (GST) payments, the deposit of withdrawn Rs 2,000 notes, and redemption of government bonds. Other factors are higher government spending and the sale of dollars by the RBI to defend the rupee from depreciation.
The implications of increased liquidity
Increased liquidity can result in elevated levels of inflation and maintain low interest rates in the market. To manage this situation, the RBI takes action if liquidity levels deviate from its comfort range. Under its Liquidity Adjustment Facility, the RBI injects liquidity into the banking system via repos and draws it out using reverse repos, depending on liquidity conditions.
RBI’s tools to control the money supply
The RBI employs various instruments of monetary policy, such as the repo rate, reverse repo rate, and Liquidity Adjustment Facility (LAF), to control the money supply in the economy. Other strategies used by RBI include Marginal Standing Facility (MSF), Corridor, Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open Market Operations (OMOs), and Market Stabilisation Scheme (MSS).
Examining the money multiplier effect
In macroeconomics, the money multiplier is crucial as it determines the money supply. It shows the amplified change in the money supply resulting from the addition of extra reserves into the banking system. The most basic multiplier used for calculating this effect is computed as change in income divided by change in spending. An increase in bank lending should translate to an expansion of a country’s money supply. Hence, the money multiplier in an economy increases with an improvement in the banking habits of the people.
Assessing the health of the Indian economy
One way to gauge the health of the Indian economy is to evaluate it against key performance indicators like steady GDP growth and low inflation. Some experts believe that these factors are indicative of a robust economy, but this view may vary depending on different economic theories and perspectives.