The Reserve Bank of India (RBI) may need to inject an additional Rs1trn (trillion) or Rs1 lakh crore in liquidity into the banking system by the end of March to stabilise financial markets, according to a research report by the State Bank of India (SBI). The report warns that the current liquidity crunch, driven by foreign exchange (forex) market interventions, tax outflows, and capital market volatility, requires sustained and flexible policy measures.
Since December 2024, India's banking system has faced its worst liquidity squeeze in over a decade. Systemic liquidity shifted from a surplus of Rs1.35 lakh crore in November to a severe deficit of Rs2.07 lakh crore in January before slightly improving to Rs1.59 lakh crore in February. This strain has been exacerbated by year-end tax outflows and increased credit demand.
"There is now inadvertent cash leakage. Since Mahakumbh, the withdrawal has been largely by retail depositors whereas the accretion of fresh deposits has been with non-retail participants and hence a significant part of the currency may not come back to systemic deposits, at least by March end," SBI says, adding, "System liquidity is still at a deficit of about Rs1.6trn (as of end-February) while the average deficit is higher at around Rs1.95trn. We believe around Rs1trn more will still be needed by March to keep the systemic liquidity in equilibrium mode."
According to the report, the Indian banking system experienced its worst liquidity crunch in over a decade. The system liquidity moved from a surplus of Rs1.35 lakh crore in November to a deficit of Rs0.65 lakh crore in December, further to Rs2.07 lakh crore deficit in January and Rs1.59 lakh crore in February.
In response to the liquidity situation, RBI has taken a series of steps, including multiple variable rate repo (VRR) auctions, a 25bps (basis point) repo rate cut, and significant open market operations (OMOs). The central bank has also conducted dollar-rupee swaps to manage forex-related liquidity drains but, despite these interventions, market pressures remain high, SBI says.
Adding to liquidity woes, foreign institutional investors (FIIs) have pulled out Rs34,574 crore from Indian equities in February alone, contributing to total outflows of Rs1.12 lakh crore in the first two months of 2025. The SBI report highlights that despite strong domestic institutional investments (DIIs) of about Rs3.3 lakh crore, FII outflows have increased market volatility and constrained liquidity.
The SBI report suggests that RBI's current approach, which primarily relies on short-term liquidity injections, may not be sufficient. It recommends more durable solutions, including a possible reduction in the cash reserve ratio (CRR) and continued OMOs targeting government securities. Furthermore, it urges states to spread their bond issuances evenly throughout the year to avoid last-minute funding pressures exacerbating liquidity stress.
Corporate bond yields have risen sharply, with spreads over the repo rate widening to 125bps, reflecting higher borrowing costs. Similarly, despite RBI's monetary easing efforts, commercial paper (CP) and certificate of deposit (CD) rates have hardened.
The SBI report warns that if the current liquidity deficit persists, it could hamper credit availability and slow economic growth.
"With an estimated liquidity shortfall of Rs1.6trn (Rs1.6 lakh crore) at the end of February and projected durable liquidity needs of Rs1trn (Rs1 lakh crore) by March, the RBI faces a challenging balancing act," SBI says.
The report underscores the need for a more dynamic liquidity management framework, emphasising that relying on temporary liquidity injections alone may not be sustainable in the long run.
As the financial year-end approaches, market participants will closely watch RBI's next moves to see whether additional liquidity measures will be implemented to ensure financial stability.
