India’s Liquidity Cycle May Not Be Driven by Policy Alone

India’s banking system liquidity is usually explained through the Reserve Bank of India’s policy actions—repo rates, liquidity operations and open market interventions. But the central bank’s data from a recent period suggests that another variable may be moving alongside these conditions: the cash balances of state governments held with the central bank.

The RBI’s weekly statistical supplement provides two relevant datasets. The first is the RBI balance sheet, which reports deposits of the central and state governments. The second is the RBI’s liquidity operations data, which shows how much liquidity is being injected into or absorbed from the banking system.

The author examined RBI’s weekly statistical supplement datasets and identified one recent period—March to May 2023—where movements in state government balances coincided with tight liquidity conditions.

State government deposits with the RBI rose to elevated levels at the end of March 2023 and then declined rapidly over the following weeks.

Source: RBI Weekly Statistical Supplement

Between end-March and mid-May, state balances declined by nearly ₹3 trillion. By comparison, the Centre’s balances in the same dataset remain largely unchanged across weeks, indicating that this variation is specific to the states. During this period, RBI liquidity data shows that the banking system was in absorption mode.

Date	Net liquidity   (₹ billion)
Mar 31, 2023	(-) 1,978.28
Apr 3, 2023	(-) 2,916.45
Apr 5, 2023	(-) 3,490.91

Source: RBI Weekly Statistical Supplement
* Note: Negative values indicate that liquidity was being absorbed from the system or that conditions were tight.

The two datasets show that:

1. State government balances were elevated at end-March 2023
2. System liquidity was in significant absorption during the same period
3. As state balances declined over the following weeks, liquidity conditions moved away from the most extreme levels of absorption

The data, to be sure, does not establish a direct causal relationship between these movements. Liquidity conditions are influenced by multiple factors, including RBI operations, currency demand and capital flows.

However, the scale of the fiscal movement is material. A change of nearly ₹3 trillion in state balances over a few weeks is comparable to the size of liquidity operations visible in the system.

The RBI’s data shows a distinction between the Centre and the states: the Centre’s balances remain largely stable, while state balances move sharply over short periods.

These movements occur alongside periods of changing liquidity conditions in the banking system.

This, to be sure, does not make state balances a standalone explanation for liquidity. 

But it suggests that state-level fiscal cash movements may form part of the broader set of variables that coincide with how liquidity evolves over time.

This distinction matters because most discussions of liquidity focus on monetary policy tools. 

Data from this period suggests that fiscal cash balances – particularly at the state level – may also be relevant in understanding short-term liquidity conditions.

While the interaction is not straightforward and the relationship is not exclusive, the magnitude and timing of these movements indicate that liquidity conditions may not be shaped by policy alone.