Goldman Sachs sees India facing major liquidity challenge

Investing.com -- India's banking system liquidity has climbed to 3.6% of net demand and time liabilities, or around 10 trillion rupees, after foreign currency non-resident deposits brought in $127 billion, according to Goldman Sachs. The inflows exceeded both market expectations and the bank's own projections.

Most of the funds arrived late in August, pushing the overnight call rate below the repo rate, Goldman Sachs said.

The Reserve Bank of India needs to absorb between 1.5% and 2.5% of NDTL, equal to 4.0 trillion to 6.5 trillion rupees, during the September-December period. The exact amount depends on how much of the short foreign exchange forward book the RBI permits to mature within the 12-month period.

About half of the required absorption will likely use permanent tools such as open market operation sales if needed, while the remainder can be managed through temporary operations, Goldman Sachs said. A seasonal increase in currency in circulation should later reduce the surplus to around 1.0% of NDTL by March 2027.

Different liquidity absorption methods carry varying costs. Temporary tools like variable rate reverse repos and term reverse repos create interest costs for the RBI, while Market Stabilization Scheme issuance transfers the cost to the government's fiscal account. Open market operation sales would likely push up bond yields amid high global rates, while a higher cash reserve ratio would burden banks by increasing non-remunerated reserves.

Goldman Sachs expects a mix of temporary and permanent measures to manage liquidity in this cycle.

Improved net foreign direct investment inflows, bond inflows since June, and moderately positive equity inflows indicate reduced balance of payments stress. The bank expects the RBI to use the FCNR deposits to reduce forward FX liabilities and rebuild reserves, keeping the dollar-rupee exchange rate largely range-bound.

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