Prelims level : Economy Mains level : Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
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In News:

The average liquidity deficit in the banking system in the week ended February 28 moderated significantly to Rs 94,585 crore, against the deficit of Rs 1.28 lakh crore ‘an eight-week high’ in the preceding week.


  • Foreign portfolio investors (FPIs) have pulled out close to $1.3 billion from the bond markets in February. Increasing border tensions coupled with other emerging economies providing better yields have prompted foreign investors to pull out from Indian markets The banking sector continues to be in deficit for the 21st consecutive week, despite the liquidity infusion by the RBI through OMOs worth Rs 37,500 crore in February. The central bank had conducted OMOs worth Rs 50,000 crore in December and January. According to a CARE Ratings report, the fall in deficit by Rs 34,266 crore was on account of higher government spending towards salaries and pensions, and liquidity infusion of Rs 12,500 crore through open market operations (OMOs) by the Reserve Bank of India (RBI). Non-food credit or loans to individuals and companies grew 14.3 per cent year-on-year (y-o-y) during the fortnight ended February 15, marginally slower than 14.4 per cent y-o-y reported in the previous fortnight.
  • It has surpassed the deposit growth, recorded at 10.2 per cent. The lower deposit growth amid higher credit growth has been a factor contributing to the liquidity constrains in the banking system.

Foreign Portfolio Investment:

  • The term FPI was defined to align the nomenclature of categorizing investments of foreign investors in line with international practice. FPI stands for those investors who hold a short-term view on the company, in contrast to Foreign Direct Investors (FDI).
  • FPIs generally participate through the stock markets and gets in and out of a particular stock at much faster frequencies. Short term view is associated often with lower stake in companies. Hence, globally FPIs are defined as those who hold less than 10% in a company. In India, the hitherto existing closest possible definition to an FPI was Foreign Institutional Investor.

Features Of FPI:

  • Portfolio Investment by any single investor or investor group cannot exceed 10% of the equity of an Indian company, beyond which it will now be treated as FDI.
  • FPIs are not allowed to invest in unlisted shares. In respect of those securities, where FPIs are not allowed to invest no fresh purchase shall be allowed as FPI. They can only sell their existing investments in such securities.
  • However, an exception has been made by permitting them to invest in unlisted non-convertible debentures/bonds issued by an Indian company in the infrastructure sector, where ‘infrastructure’ is defined in terms of the extant External Commercial Borrowings (ECB) guidelines; FPIs are permitted to invest in Government Securities with a minimum residual maturity of one year. However, FPIs have been prohibited from investing in T-Bills.
  • FPI can invest in privately placed bonds if it is listed within 15 day.

Liquidity measurements:

The total stock of money in circulation among the public at a particular point of time is called money supply. The measures of money supply in India are classified into four categories M1, M2, M3 and M4 along with M0. This classification was introduced in April 1977 by Reserve Bank of India.

1. Reserve Money (M0):

    It is also known as High-Powered Money, monetary base, base money etc.

    M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI

    It is the monetary base of economy.

2. Narrow Money (M1):

    M1 = Currency with public + Demand deposits with the Banking system (current account, saving account) + Other deposits with RBI

3. M2 = M1 + Savings deposits of post office savings banks

4. Broad Money (M3):

M3 = M1 + Time deposits with the banking system

5. M4 = M3 + All deposits with post office savings banks

  • The liquidity means how fast an instrument can be converted into cash. The liquidity of these measures are in order M1>M2>M3>M4 i.e. M1 is most liquid and M4 is least liquid. It is the relationship between monetary base and money supply in economy. The amount money that banks generates with each unit (Rs in case of India) of money. It is the ratio of deposits to the reserves in the banking system.
  • For example, let’s say total deposit in banking system is $100 and reserve ratio requirement is 10%.
  • The banks can lend 90% of deposit i.e. $90. This $90 that banks will lend to its customers will ultimately be deposited in another bank which can further lend 90% of that i.e. $81 and cycle continues.
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