The pressure on liquidity appears to be easing now; but the second half of this fiscal is likely to witness renewed concerns on banks’ liquidity position

For the moment, banks in the country are breathing easy, after witnessing prolonged suffocation on the liquidity front until a few weeks ago. The limited action in the central bank's liquidity adjustment facility (LAF) in the past few days is reflective of this. However, the question is whether this liquidity position is sustainable over the second half of this fiscal year.

Some analysts are not entirely comfortable with the cash position of banks. In fact, Nomura Financial Advisory and Securities mentions in its report that a sharp rise in currency in circulation will add to the liquidity strain by the second half of this fiscal. Rising economic activity, coupled with high inflation, has led to a pick up in currency in circulation. This will gain further momentum in the latter half of this year on account of the festival season, food procurement and pick up in agro-based industrial activities, states the report.

"An increase in currency in circulation will likely be a further negative for systemic liquidity, which is already close to zero. We expect advanced tax outflows in mid-September and the seasonal increase in currency in circulation to add to liquidity pressures as we head into H2FY11, offsetting most of the gains from higher government spending," says the Nomura report.

This is contrary to the normal phenomenon when a surge in money circulation tends to ease liquidity pressures in the system. Given the high level of inflation and the festive season around the corner, people will prefer to keep large cash levels with them. A banking sector analyst from BRICS Securities told Moneylife, "During inflationary times, currency with people is at a high - strange howsoever it may seem. There will also be (the) seasonality effect because during a festive season, cash in hand with the people goes up. The more the currency with people, the less there will be with the banking system."

Clyton Fernandes, banking analyst at Anand Rathi, feels that the liquidity position may change depending on how the credit demand in the second half pans out. "The liquidity position is looking comfortable as of now because credit demand has not picked up across segments - it is still tilted towards infrastructure and housing. When it starts getting broad-based in the second half, that is when liquidity will tighten a lot more."

Deepak Tiwary, banking sector analyst with KR Choksey said, "Currently there is not much pressure on the system. Except for Monday, when banks borrowed heavily from the LAF window of the RBI, banks have been sitting pretty on the liquidity front. However, some banks might have to resort to borrowing." He feels that if liquidity problems start to pose a serious challenge, the RBI will intervene in the way it did in June.

DK Joshi, chief economist at CRISIL, has a different perspective on the situation. He believes that the liquidity situation will ease further from the current level when government spending picks up in the second half of this year.