Six week Long National Election Leads To RBI Liquidity Dilemma

As India’s national elections unfold over an extended six-week period, the Reserve Bank of India (RBI) has taken proactive steps to ease liquidity strains within the banking system. The prolonged election season has led to a slowdown in government spending despite robust tax collections, prompting the RBI to inject liquidity through various measures.

Voting commenced on April 19 and is scheduled to conclude on June 1, with the counting of votes set for June 4. Historically, government expenditure tends to decelerate during election periods, typically picking up momentum once a new government is established and a budget is presented.

In a recent move aimed at bolstering liquidity, the government announced a surprise buyback of bonds worth Rs 40,000 crore ($4.8 billion). This buyback initiative is expected to infuse much-needed funds into the banking system, leading to a reduction in bond yields. Yields on bonds maturing in 2-5 years witnessed a decline of 3-5 basis points following the announcement, with longer-term yields also experiencing a cooling effect.

Experts view this bond buyback as a strategic liquidity-enhancing maneuver amidst the current economic scenario. Gaura Sen Gupta, an economist at IDFC FIRST Bank, highlighted that reduced government spending during election periods has necessitated such liquidity injections to maintain financial stability.

Anitha Rangan, an economist at Equirus Group, pointed out the significant drop in government spending during the April-June period, attributing it to the ongoing elections. This decrease in spending has underscored the importance of liquidity management measures by regulatory bodies like the RBI.

The RBI has been actively intervening to mitigate liquidity challenges, having infused Rs 1.7 lakh crore through variable rate repo auctions since mid-April, according to Citi economists. This proactive approach by the central bank is in anticipation of potential delays in government spending decisions due to election-related factors, which could further tighten liquidity conditions.

Furthermore, analysts at Citi noted that while the RBI’s dividend is expected to be transferred to the government in May, spending might experience delays owing to the ongoing elections. This scenario underscores the importance of continuous liquidity support measures to ensure economic stability during critical periods.