India's banking system is currently facing a significant liquidity surplus, estimated at around $127 billion, primarily due to higher-than-forecasted dollar inflows from special schemes designed to attract funds from overseas Indians. This influx has pushed the surplus cash in banks to an all-time high, reaching approximately ₹10.5 trillion ($127 billion), and is projected to reach ₹14.17 lakh crore ($170 billion) by mid-September. This surge in liquidity has caused the overnight interest rate to fall below the Reserve Bank of India's (RBI) benchmark rate, complicating the central bank's monetary policy objectives of keeping the weighted average call rate close to the policy repo rate of 5.25%.
To address this challenge, the RBI is stepping up its efforts to absorb the excess liquidity. One key measure involves locking up excess banking cash for longer durations. For instance, the Bank of India will hold a ₹7 trillion ($74.1 billion) 30-day variable rate reverse repo (VRRR) auction. However, initial attempts at longer-tenor VRRR auctions have seen an underwhelming response. For example, a ₹7 lakh crore ($84 billion) 30-day VRRR auction received bids for only ₹2.59 lakh crore ($31 billion). Analysts expect the RBI to utilize a mix of continued VRRR operations, including both short and long tenors, and potentially an incremental cash reserve ratio (I-CRR) hike.
Union Bank of India (UBI) research suggests that while the RBI may not need an immediate CRR hike, due to expected moderation of the surplus through FY27, flexible tools like VRRR auctions and forex swaps will be prioritized. UBI's report outlines that the projected ₹14.17 lakh crore ($170 billion) surplus could be absorbed through a 50:50 mix of temporary/reversible measures like short-tenor VRRR auctions (estimated $85 billion) and longer-duration tools such as long-tenor VRRR, I-CRR, FX sell-buy swaps, and Open Market Operations (OMO) bond sales (totaling another $85 billion). While an I-CRR is a possibility, it could penalize lenders that received higher flows under the swap scheme that initially had CRR exemptions.
Barclays Bank economists also anticipate a mix of VRRR and I-CRR, but do not expect permanent liquidity absorption tools such as a system-wide CRR hike, OMO sales, or a policy rate hike in October. Seasonal factors like increased currency demand and festive spending from September to November are also expected to help absorb some of the surplus. The RBI's ultimate goal is to normalize liquidity conditions, starting with restoring the overnight rate as the anchor for policy rates and then absorbing medium-term excess liquidity.
