The RBI's liquidity accommodation to banks through various routes has been an unprecedented R1.5-2 lakh crore over the last four years even as money market rates have hardened.
While much of the tightness in liquidity has been due to dollar outflows, credit growth outpacing deposit growth and the government's increasing market borrowing, one constant source of tightness has been the rise in currency in circulation.
RBI data show that currency with the public grew 9.4% in 2013-14 to R13 lakh crore. This is on the back of a growth of 11.6% in the previous year and 12.2% in 2011-12.
During this year, RBI, on an average, has been pumping in R60,000 crore into banks through its daily repo auctions. Over and above these, the central bank infused R16,000 crore through bond purchases and provided nearly R1 lakh crore through term repos of various tenures.
As on April 11, the currency with the public had grown 9% year-on-year. The high double-digit retail inflation over the past years has led to an increase in currency holdings by the public.
As investments in financial assets, especially bank deposits, fell, those in physical assets such as real estate and gold that traditionally have a high cash component rose.
The fact that inflation was high and a decline in the financial savings of households has shown up as a rise in cash, said Abheek Barua, chief economist, HDFC Bank.
Economists and market participants have pointed out that this leakage makes it difficult to tamp down the liquidity deficit of the system.
Although on the aggregate level, there could be an improvement in the liquidity this year as things should pick up in terms of reserve money, it is unlikely that rates would reflect this improvement, said Barua. Besides inflation, festivals and elections also contributed to the increase in currency circulation.
There is a seasonality to this currency circulation. Currency leakage has been high and, in some years such as election years, it is even higher, said Shubhada Rao, chief economist, YES Bank.
As inflation eases and the pace of growth in currency with the public slows, economists said that the liquidity situation would improve this year.