As India’s financial year draws to a close, the Reserve Bank of India (RBI) has moved decisively to address emerging liquidity strains in the banking system. With tax outflows and seasonal cash leakages tightening financial conditions, the central bank has announced a fresh cash infusion of approximately Rs 1.9 trillion. In a bid to stabilise short-term interest rates and ease funding constraints, the RBI will conduct open market operations (OMOs) to purchase Rs 1 trillion worth of government securities in two tranches—Rs 50,000 crore on March 12 and another Rs 50,000 crore on March 18.
These interventions underscore the RBI’s balancing act between financial stability and monetary policy objectives at a time of heightened domestic and global uncertainties.
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India’s Liquidity Situation
The banking system has been facing a cash deficit for the past 11 consecutive weeks. Although the latest data shows the deficit narrowing to Rs 20,000 crore last week, there are clear signs of a severe cash crunch. The weighted average call rate (WACR) has been exceeding the repo rate, reaching 6.58% in December 2024 and 6.69% in January 2025. This deviation from the typical WACR corridor (between the repo and reverse repo rates) was further confirmed by a notable 25-30 basis point rise in three-month certificate of deposit (CD) rates in mid-December, compared to a marginal 9-10 basis point increase in 10-year bond rates.
The credit spread between the repo rate and three-month CD rates, which was negative during the high-liquidity period of FY21, has now widened to approximately 119 basis points. While the liquidity shortfall—measured through lenders’ borrowings from the central bank—has eased to Rs 793 billion ($9 billion) as of March 6 from a near 15-year high of Rs 3.3 trillion in late January, concerns persist about the depth of the cash flow crisis.
Banks have been urging the RBI to introduce further liquidity measures due to the ongoing market stress. While overnight rates remain below the repo rate, longer-term money market rates—including three-month, six-month, and one-year CDs—continue to stay elevated. A significant 150 basis point gap between the three-month CD rate (approximately 7.55%) and overnight rates is hampering the smooth transmission of interest rate reductions.
Factors Worsening the Liquidity Deficit
India’s liquidity crunch has been exacerbated in part by the RBI’s dollar sales aimed at protecting the rupee from global headwinds. The local currency has been hitting successive lows but recorded its highest single-day gain since February 11, thanks to a weakening dollar and dollar sales by state-owned banks acting on behalf of the RBI.
The banking system is also preparing for further cash outflows due to quarterly advance tax payments by companies to the government before the financial year-end in March. Additionally, the RBI must manage liquidity outflows related to mid-March and GST payments due before the end of the month. Beyond tax-related outflows, volatility in global trade policies—especially uncertainties stemming from U.S. President Donald Trump’s tariff actions—adds another layer of economic uncertainty. The U.S. has imposed 25% tariffs on imports from Mexico and Canada while doubling duties on Chinese imports to 20%, with India also facing potential tariff pressures from the U.S.
The Need to Curb Liquidity Volatility
Effective liquidity management is crucial for ensuring smooth monetary policy transmission and the overall stability of the financial system. By aligning short-term interest rates with the policy rate, the RBI plays a pivotal role in supporting economic growth and financial stability. Although liquidity management has short-term implications for financial markets, its long-term effects influence consumption, investment, and capital formation in the economy. Maintaining optimal liquidity levels allows banks to continue lending to businesses and consumers, sustaining economic activity in India.
Regulatory compliance also necessitates stringent liquidity management. The RBI has implemented liquidity requirements such as the Liquidity Coverage Ratio (LCR) to ensure banks can meet short-term obligations. Proper liquidity management helps banks comply with these regulatory norms, while also enabling them to absorb sudden foreign capital inflows or outflows, mitigating systemic risks. A liquidity shortage in major banks can quickly ripple through the financial system, necessitating a proactive approach from the central bank.
Since late January, the RBI has injected approximately $68 billion into the financial system. The ongoing liquidity infusion efforts are expected to create a surplus by the end of March, facilitating better transmission of interest-rate cuts and bolstering economic expansion, which is currently projected to be the slowest in four years.
RBI’s Proactive Approach
The central bank has reaffirmed its commitment to closely monitoring liquidity and market conditions, vowing to take necessary measures to ensure financial stability. These actions highlight the RBI’s proactive stance in navigating evolving economic challenges. Experts believe that the central lender has sufficient room to inject an additional Rs 2 trillion into the financial system in the upcoming fiscal year, starting April 1.
In the coming weeks, the success of RBI’s measures will depend on how effectively it balances liquidity management with inflation control and financial stability. While the central bank has taken decisive steps to ease pressures, market participants remain watchful of potential policy shifts as global and domestic financial conditions continue to evolve.