Public sector banks Bank of India (BoI) and Central Bank of India have raised

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interest rates paid on deposits suggesting liquidity tightening is on the horizon, but bankers say excess liquidity in the system as a whole is expected to last till the first quarter of 2010-11.

Bank of India has raised deposit rates by up to 50 basis points (bps) last week and Central Bank of India increased its deposit rates by up to 150 bps since March 15. "Bank of India became the first PSU bank to raise its deposit rates signaling the bottoming of deposit rates and also lending strength to other voices around a liquidity challenge emerging," said Aditi Thapliyal, banking analyst at UK-based investment banking firm, Execution Noble's India, in a note.

The liquidity overhang in the banking system will continue till June-July of the next financial year, say banking/industry experts.

The system has been flush with liquidity for the entire year due to capital inflows (foreign institutional investor inflows of Rs 100,000 crore), the Reserve Bank of India buying dollars and poor credit off take. The money kept by banks in the repository of the Reserve Bank of India (repo) has seen a decline from Rs 124,000 crore in November-December of last year to just Rs 4,230 crore as on March 15 by way of reverse repo auctions.

This is far from indicating that the liquidity in the system has vanished, say bankers. Experts attribute this outflow to banks parking money with liquid mutual funds, other avenues of earning more yield and advance tax outgo. The yield on the reverse repo offered by the apex bank is around 3.25 per cent.

“The money has gone to alternative preferred options of investment. Anywhere there is a higher yield, money is being parked there by banks,” ADM Chavali, general manager of treasury and resource management, Bank of Baroda, said. According to Chavali, liquidity in the system has not come down. Around Rs 100,000 crore has been invested by banks in liquid mutual funds, while Rs 50,000 crore has gone as advance tax in the January-March quarter, say bankers.

Thapliyal of Execution Noble, however, said there is an increasing segment highlighting that private sector borrowing is picking up amid the first-half weighted government borrowing programme, likely resulting in a fight for liquidity.

The government’s borrowing programme and pickup in credit offtake by manufacturing and other industries is expected to start by the second quarter of the next financial year. “The money that has gone to liquid mutual funds and as advance tax will come back in the system within a month,” said S K Dubey, general manager of treasury and international banking division of PNB. According to Dubey, the liquidity in the system will continue for some more time. “Till June-July next year, there will be comfortable liquidity in the system after which some strain is expected,” Dubey added.