New Delhi: Indian banks’ apex body Reserve Bank of India may buy as much as government bonds worth $18 billion to recharge banking liquidity as there is a higher possibility for tightening of the cash flow by the end of the year.

The Reserve Bank of India is likely to cut the cash reserve ratio (CSR) by half a point in the fiscal second half and will start buying bonds in the third quarter in order to maintain banking liquidity at current levels, as per B. Prasanna, group head for global markets sales, trading and research at ICICI Bank Ltd, the nation’s second-largest private lender by market value, in an interview on Monday.

Impact on cash flow due to elections

As elections of Rajasthan, Madhya Pradesh and Chattisgarh are due later this year, a shortage of cash is likely to occur in the banking system because of higher spending amid state elections of the above-mentioned states, which will coincide with the busy credit season in October when demands soar in the economy.

Lenders like Kotak Mahindra Bank Ltd. say that RBI’s step of withdrawing the Rs 2,000 denominations from the economy in the month of May will recharge liquidity after which RBI’s probability of purchasing bonds will be lowered in the fiscal second half.

How will it impact liquidity?

With this move, it is anticipated to add about one trillion rupees in banking liquidity. It is followed by the RBI’s higher-than-expected dividend payout to the government, which may also trigger cash flow in the system.

The current liquidity addition has brought down funding rates, creating scope for a rally in notes maturing in five years and less, Prasanna said. The 5-year yield may drop to 6.8% levels, while the one-year treasury bill can fall to 6.75%, he said. The 10-year bond doesn’t have much scope for a rally now with interest rates expected to have peaked, he added.