The Reserve Bank of India’s surprise announcement to buy up to ₹1.25 trillion in government bonds in May marks a sharp escalation in its liquidity operations. This follows more than ₹7.1 trillion in durable liquidity injections since December and signals a decisive attempt to address emerging signs of economic softening.

Monetary aggregates, including money supply and reserve money, are expanding more slowly than last year, indicating restrained base liquidity growth. Credit momentum has also eased, with bank lending growth not keeping pace with last year's trend. 

In April, the RBI revised its GDP growth forecast for 2025-26 to 6.5% from 6.7%, though several economists now expect growth to slip below 6%.

The May bond purchase plan is not merely a routine liquidity operation. The RBI has scheduled two open market operations in the first week of May, a rare clustering that underscores the effort to frontload support. The likely transfer of about ₹2.5 trillion in dividends from the RBI to the government will further add to systemic liquidity.

This strategy aligns with a broader monetary pivot. Since February, the RBI has cut the repo rate by 50 basis points and shifted the policy stance from neutral to accommodative. Policy rates, liquidity operations, and bond market management are now being coordinated to ease funding conditions and support monetary transmission.

Two government securities totalling ₹1.35 trillion are set to mature in May and June. The RBI may hold some of these securities and replenishing stock appears to be one of the considerations. The principal aim is to inject durable liquidity in advance to revive trading volumes, enable smoother absorption of government borrowing, and accelerate lending rate transmission.

Operational constraints also shape the RBI’s approach. Balance sheet growth in 2024-25 was subdued at 9.6%, with most of the increase occurring in the January–March quarter. Liquidity conditions remained tight for much of the year, partly due to currency leakage and sterilisation pressures. Given that foreign exchange interventions are limited by global volatility, domestic bond purchases have emerged as the RBI’s most reliable tool for expanding liquidity.

Market estimates suggest the RBI’s balance sheet will need to grow by 10–11% in 2025-26 to adequately meet systemic funding requirements.

Government borrowing has further heightened the urgency. Of the ₹14.82 trillion borrowing planned for 2025-26, ₹8 trillion is scheduled in the first half, with ₹1.2 trillion slated for May. In the absence of proactive RBI intervention, this front-loaded supply could tighten liquidity, especially if government spending is delayed. The RBI may also want to ensure smooth sailing at these auctions so that signalling across markets remains consistent and the pressure on banks to lower rates is sustained. The central bank’s advance liquidity injection helps ensure this supply is absorbed without crowding out private credit or exerting upward pressure on yields.

A central objective of the RBI’s strategy is to reanimate an inert bond market. Last year, Indian bond yields were unusually sticky despite softening global rates. Trading volumes were thin, and the transmission of policy rate cuts into market rates was muted. Persistent liquidity tightness and uncertainty over the RBI’s policy stance contributed to this misalignment. Under new leadership, the RBI is seeking to correct this. Active bond purchases aim not only to infuse liquidity but also to deepen market activity. A more vibrant bond market is essential for efficient rate transmission and for bolstering private sector borrowing.

The RBI's strategy is not without risks, as surplus liquidity may distort price signals and delay adjustments. Rate transmission may continue to vary across instruments and maturities. Nevertheless, the RBI appears intent on advancing balance sheet expansion to align financial conditions with its monetary stance.

The real test of this strategy will be whether it succeeds in lifting credit demand and investment activity in the months ahead.

The RBI has taken a forward position. What remains to be seen is whether the economy responds in kind. 

This is an updated version of the copy filed on Monday night.