Due to lower government spending and slower growth in bank deposits relative to credit, the banking system liquidity gap increased to over Rs 2 lakh crore on January 15, just two weeks before the Interim Budget was announced.

The Reserve Bank of India’s (RBI) injection of funds into the banking system indicates the liquidity deficit, which was recorded at Rs 2.11 lakh crore on Monday. This is the highest level since December 28, when the deficit was recorded at Rs 2.68 lakh crore. The advance tax and goods and services tax (GST) payments were the cause of the December liquidity deficit.

Banks Face ₹2 Lakh Crore Liquidity Gap

The reason for liquidity tightness is that deposits are increasing more slowly than credit. Both have slowed, but deposits have diverted more than credit has. As a result, the system is experiencing a liquidity crunch, according to Bank of Baroda Chief Economist Madan Sabnavis.

According to the most recent RBI data, during the two weeks that concluded on December 29, bank deposits increased by 13% year over year (y-o-y), while credit increased by 20%. The impact of HDFC and HDFC Bank’s merger is included in the growth. By December 2023, bank deposits had risen by Rs 23.48 lakh crore, reaching Rs 200 lakh crore.

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According to Sabnavis, a significant portion of retail deposits have moved to mutual funds, making the growth of deposits difficult.

“This liquidity deficit situation may be expected to persist as funds are flowing to mutual funds, which will challenge deposit growth even if credit growth slows down, albeit slightly,” the speaker stated.

According to the most recent data from the Association of Mutual Funds in India (AMFI), the mutual fund industry’s assets under management reached a record high of Rs 50.77 lakh crore in December 2023. The AUM of the mutual fund sector increased by about Rs 11 lakh crore in 2023.

Analysts say the government’s increased cash holdings also tighten the general liquidity. Government spending decreased recently and was anticipated to grow in the fourth quarter of the current fiscal year. They did note, though, that fiscal consolidation is receiving more attention.

Soumyajit Niyogi, Director of Core Analytical Group, India Ratings and Research (Ind-Ra), stated, “We thought the government would spend higher than usual in the last quarter (Q4), but it seems they are prioritizing fiscal consolidation and so, the spending is lower which, in turn, has tightened the liquidity situation.” The projected fiscal deficit for 2024 is 5.9% of GDP.