Solving RBI’s Liquidity Conundrum

In many ways, 2025-26 has been exceptional with RBI infusing liquidity on the front foot via all instruments at its disposal. RBI has infused ₹9.4 trillion or 2.6% of GDP as durable liquidity via OMO purchases and CRR cut. Whenever a Central Bank undertakes liquidity infusion or quantitative easing, its balance sheet expands. In 2025-26, RBI’s balance sheet has expanded by less than that amount (1.5% of GDP) to 24.3% of GDP from 22.8% of GDP in 2024-25. This is because ₹3 trillion or 0.8% of the GDP of rupee liquidity has been lost due to dollar sales by the RBI.

The need for dollars rose due to a large balance of payments deficit, forcing the RBI to bridge the gap. The dollar funding gap is also reflected in the sharp depreciation pressure on the rupee and has been caused by capital outflows.

Another factor which contributed to net dollar selling is how RBI managed its forward book, which has reduced to $62.35 billion net dollar short as of December 2025 from $84.3 billion net dollar short as of March 2025.

In January–February 2026, the RBI conducted $20 billion long-term buy-sell swaps. It’s likely that the majority of this has gone into elongating the maturing of the forward book rather than actual liquidity infusion. The fact that the forward book is currently lower than March 2025 levels indicates that swaps have matured, and the RBI had to deliver dollars. This is also responsible for the ₹3 trillion liquidity drain from dollar selling by the RBI, apart from the BoP deficit.

How much of the 1.5% of GDP liquidity infused by the RBI has remained in the banking system is also important, as it determines financial conditions.

In this regard, currency leakage (or cash) is an important determinant. Whenever people withdraw cash from the banks, it reduces the banking system's liquidity. In 2025-26, there has been a significant rise in currency leakage, currently tracking at ₹2.8 trillion over April to January or 0.8% of GDP. For the same period last year, currency leakage was just ₹849 billion.

This surge in cash utilisation has taken place alongside the rising penetration of UPI. One of the factors behind the surge is likely a strong revival in rural demand conditions, which were on a weak footing in 2024-25. The rural economy tends to be cash-intensive, which explains the sudden rise in utilisation of cash. Hence, considering that about half of the infusion has been lost due to higher cash withdrawals. 

This explains why core liquidity or durable liquidity of the banking system has risen by just ₹2.5 trillion in 2025-26 (April–January 23) or 0.7% of GDP, despite unprecedented liquidity infusion by RBI.

Another unique feature of 2025-26, which has complicated matters for the RBI, is the widening gap between credit and deposits in the banking system. As of mid-January 2026, the credit-to-deposit ratio has risen to a fresh historical high of 82%, as credit growth outpaces deposits. This has created pressure in money markets with a rise in CD rates, as banks compete to raise funds. A unique feature of the current rate cut cycle has been the rise in the credit-to-deposit ratio. In the past rate-cutting cycle, the credit-to-deposit ratio has usually fallen.

Finally, government cash management has also impaired the efficacy of RBI liquidity infusion. Over the last few years, cash surplus has remained elevated for the majority of the financial year and dipped only in the second half of March. This reflects the expenditure pattern of state governments, which undertake 33% of their expenditure in January–March of the financial year.

Due to an elevated cash surplus for the majority of the financial year, system liquidity surplus gets depressed even when core liquidity surplus is high. For instance, as of January 23, 2026, core surplus was ₹4.6 trillion, but the majority of that was locked in government cash surplus, tracking at ₹4 trillion.

The solution to RBI’s liquidity conundrum is to ensure that the banking system liquidity surplus is at 1% of NDTL on a consistent basis. This means that even during tax payment days, when there are large outflows from the banking system liquidity (GST payment or advance tax), system liquidity remains at 1% of NDTL.

For this, core liquidity needs to be closer to 2% of NDTL.