There is nothing called 'free money' in the economy. It costs even if the money is provided by none other than the one who prints it -- the Central Bank. Yes, the huge surplus liquidity created by the Reserve Bank of India (RBI) over the last one year to prop up the economy is probably hurting it more than risk-averse commercial banks.
The banks have been lining up at the door of the RBI to hand them back the money as hardly any lending opportunities are there in the market. The credit growth is already in the single digit. In fact, this is expected to fall further post the COVID-19 period.
The RBI's annual report has revealed that its liquidity-absorbing operations in the banking system has resulted in a net interest outgo of Rs 12,904 crore in 2019-20.
The RBI as a monetary authority earns an income under its liquidity adjustment facility (LAF) and marginal standing facility (MSF) where it mostly lends money to banks at the repo rate or at a higher rate under emergency situations.
LAF has basically two components -- the repo (infuse liquidity) and reverse repo (absorb money) operations. For the most of the last year, the banks were giving back the money to the RBI under the reverse repo facility and earning 3.35 per cent interest based on the current rate. This implies a net outgo from the RBI's balance sheet.
The banks also didn't borrow much under the MSF, which is like an emergency credit line for the banks. The interest rates under MSF are at 4.25 per cent , which are much higher than the repo rate of 4 per cent.
The RBI claims that it absorbed surplus liquidity of Rs 284.4 lakh crore through reverse repos of maturities ranging from overnight to 63 days during 2019-20.
The extent of interest loss can be gauged from the RBI's last year net interest income at Rs 1,181 crore in 2018-19. This year, the net outflow (negative) is at Rs 12,904 crore. In fact, the net outgo on liquidity operations also contributed to a lower dividend of Rs 57,128 crore from the RBI to the government.
The liquidity conditions in the market have remained in surplus mode right from June last year. The surplus liquidity conditions actually started building up from the second quarter (July-September) 2019-20. This was mainly on account of drawing down of GoI cash balances, return of currency to the banking system, and net forex purchase operations.
According to the RBI, the absorption of liquidity on a daily net average basis under the LAF increased to Rs 1.31 lakh crore during Q2 in contrast to a net injection of Rs 17,409 crore in Q1 of 2019-20.
The surplus liquidity conditions also have other negative consequences if it continues for a long-term. Given the COVID-19 disruption, the RBI is expected to continue with the surplus mode. In addition, there are large government borrowing programmes, which necessitate managing yield at the lower end for the next six months. The biggest danger is from the inflation, which is already ruling above 6 per cent. Besides, there should be enough opportunity for money multiple to push growth.