Last month, an exasperated RBI governor D Subbarao held mounting cash balances of the government responsible for the ongoing liquidity crunch. ?We were expecting the government cash balance to come down with spending, which would, in turn, have eased liquidity,? Subbarao said on November 9. The tightness is clearly beyond the level desired by RBI’s policy stance for effective transmission of interest rate hikes and keep inflation under check. The tightness in the money market can be gauged from the fact that banks’ daily average borrowings via the LAF window has been Rs 90,000 crore. Now this tightness may hurt investments and industrial production, economists worry. In the first half of this fiscal, that is in the seven months ending October 31, government’s revenues grew 56% from a year earlier. In the same period, government’s expenditure increased by merely 20%. Revenues were boosted by higher than estimated revenue collection from telecommunication spectrum sale. However, the lower government spending has led to shrinking of overall liquidity in the system. Finance minister Pranab Mukherjee on November 10 admitted tightness might have been caused by slow government spending. In the first seven months of the current fiscal, it was only 48% of the full year’s budgeted figure.
A key reason for the big build-up in government balances was slower spending by state governments, he hinted. Some analysts believe that even if government was to spend its entire cash balances, liquidity will not turn to surplus. ?Without further liquidity easing measures, even if the government spends all of its surplus cash, banking system liquidity will remain in deficit at end March,? said Nagraj Kulkarni, senior rates strategist of Standard Chartered Bank. In the coming months, the squeeze on liquidity could increase because state governments borrow more in the second-half of a fiscal year and currency in circulation increases. ?Although government spending might alleviate liquidity concerns, the increase in currency in circulation and state development loan auctions would mitigate the positive impact,? said Kulkarni. Yet another key reason for the tight liquidity condition was subdued growth of reserve money. Reserve money, a monetary measure, has been growing at 5-6% in this fiscal year so far compared with 5% in the previous year. ?The situation this year is very different. Given bank credit growth of 22% the current level of reserve money is insufficient,? said Jyotinder Kaur, an economist at HDFC Bank.