India’s 6-week long national election leaves cenbank with liquidity dilemma

MUMBAI: India’s central bank is stepping in to ease banking system liquidity conditions as a national election which stretches over six weeks is hurting government spending despite strong tax collections.

Voting in India’s national elections began on April 19 and will conclude on June 1, with counting on June 4. Typically, government spending slows during polls and picks up only after a new government is in place and a budget is presented.

On Friday, the government announced a surprise buyback of bonds worth 400 billion rupees ($4.8 billion), which will infuse funds into the banking system. Yields on bonds maturing in 2-5 years fell 3-5 basis points on Monday. Longer-term yields also cooled.

The buyback of securities is a liquidity injecting tool, and will help in easing liquidity in the system, a source familiar with the government’s thinking said.

India’s average banking system liquidity has been in deficit since April 20 and is expected stay in deficit or close to neutral this month, according to economists.

“The buyback announcement could be an exercise to infuse liquidity because we have an interim budget and the general election, so the government expenditure is lesser than usual,” Gaura Sen Gupta, India economist at IDFC FIRST Bank said.

In April-June 2023, government spending was 2.78 trillion rupees, and stood at 1.75 trillion rupees in the same period a year before, according to Anitha Rangan, an economist at Equirus Group.

“This year, April-June spending would be significantly lower than that due to elections,” she said.

India’s central bank has also stepped up short-term liquidity infusions.

Since mid-April, the Reserve Bank of India (RBI) has infused 1.7 trillion rupees via variable rate repo auctions, Citi economists said in a note on Monday.

“The RBI might be anticipating that the election-related delayed decision-making in the government might constrain spending and in turn cause further liquidity tightness,” they said.