Here's how RBI will reduce liquidity impact of 7th Pay Commission arrears

The burden due to hike in salaries and pensions under the 7th Pay Commission is unlikely to cause significant systemic liquidity disruptions, according to a India Ratings and Research (Ind-Ra) report.

The agency estimates the combined outgo for the Center on account of arrears for January to July and payments for August will total to Rs 346 billion. The banking system liquidity will experience transient frictional tightness ahead of the payment of arrears.

“The government is likely to go slow on spending as it gears up to meet lumpy payments (other than regular payments). Temporal adjustments notwithstanding, the overall liquidity conditions will be cushioned as the Reserve Bank of India (RBI) will transfer its profit to the government of India,” said Ind-Ra.

The report says that the Rs 68 billion deficit arising post the redemption of bonds and payment of arrears can be met through multiple modes such as existing cash balance with the government (Rs 82.49 billion on 11 August 2016) and drawing down of ways-and-means-advances to tide over this mismatch.

Apart from this, over August-December 2016, a seasonal surge in currency in circulation and outflows on account of FCNR B (foreign currency non-resident) deposits’ redemption could aggravate the liquidity position. The agency believes that RBI, at its end, will support the systemic liquidity through proactive management.

The RBI is already front-loading liquidity provision, to move closer to its objective of ‘bringing the ex-ante liquidity deficit close to neutrality’ and has already infused structural liquidity of Rs 905 billion this fiscal.

Consequently, any temporary liquidity pressure is likely to elicit a response from the RBI in the form of injection of durable liquidity through open market operations, said Ind-Ra. Front-loaded liquidity infusions through open market operations will keep money market rates anchored around the policy rates.

Out of the Rs 1.02 trillion gross impact of the 7th Pay Commission on the exchequer, the budget has made a provision to the extent of Rs 933.25 billion. Any shortfall arising out of the arrears’ payment is likely to be marginal and will not significantly affect the country’s fiscal position.