MUMBAI: Indian financial markets ’ liquidity position has worsened with cash deficit widening to about Rs 1.4 lakh crore this week compared with a small surplus in first week of October. The Reserve Bank of India’s efforts to improve the situation with bond purchases appear to have had little impact as dollar sales to stem a sliding rupee touched a fiveyear-high in April-August.Market worries over finance firms’ ability to roll over their debt and surging demand for cash as festival season purchases gather pace has also compounded the problem, economists and treasury heads say. The liquidity shortage in the banking system is getting magnified in the broader market with the non-banking finance companies ( NBFCs ) finding it difficult to raise funds from banks which are hoarding cash amid fears of more defaults, leading to further tightening of rates and liquidity.With mutual funds seeing outflows last month, NBFCs are looking to banks to be liberal in lending to them so that they could offset the loss of funding from mutual funds. “Core system liquidity is rapidly dwindling and may touch about Rs 2.5 lakh crore by March,” said Suyash Choudhary, head of fixed income at IDFC Mutual Fund. This implies that the RBI will have to keep up a steady pace of permanent liquidity infusion in the months ahead.” Net liquidity, or availability of cash in the system, turned deficit more than two weeks ago. Since October 9, the deficit topped.`1 lakh crore at least thrice, India Ratings data show.It reached a peak of Rs 1.4 lakh crore last Monday before falling to Rs 94,200 crore on the day after. “Currency intervention is one of the factors that is likely to have contributed to the tightening in banking system liquidity,” said Saugata Bhattacharya, chief economist at Axis Bank. Cash withdrawals in the festival season is another factor. Episodic and transient shortages are created by monthly outgoes of taxes (excise and GST), and occasionally due to bank CRR (cash reserve ratio) balances with RBI.”The RBI has intervened heavily in recent times to prop up the rupee which hit an all-time low of Rs 74.48 sometime this month. It is one of the worst performing emerging market currencies this year having fallen 12.7%. India’s forex reserves, which climbed past the $400 billion mark this year, dipped by $5.1billion as on October 12, the latest data from the central bank shows.In the five months between April and August, the RBI sold $18.6 billion in the currency spot market to try and prevent the rupee from falling. But dollar sales may have actually ended up hurting liquidity in the system as the central bank has to buy rupees and convert it into dollars before currency intervention. This ends up worsening cash shortage in the system.RBI has responded to this liquidity pressure by declaring its intention to step up bond purchases. It has bought bonds worth Rs 36,000 crore in October alone compared with about Rs 30,000 crore in the three months ended September. Open market operation is a mechanism to infuse or suck out cash from banking system. It is the central bank’s stated stance to keep liquidity at neutral. Such operations have provided some relief but with liquidity deficit climbing past Rs 1 lakh crore, economists and experts call for a more sophisticated approach.“Given the RBI has signalled for more liberalised currency regime, the liquidity management is going to be more sophisticated in the backdrop of fiscal and current account deficit with volatile capital flows,” said Soumyajit Niyogi, associate director, India Ratings and Research. “While the liquidity stance is largely committed, but the appropriate strategy is to use tools based on causation and RBI’s assessment with better information than the market,” he said. Bond market yields have actually not responded to the deficit problem so far with 10-year yields falling 43 basis points in about a month after hitting 8.23% in September. Falling crude oil prices and stabilising rupee have aided the rally.