RBI faces liquidity deluge as surplus climbs to 4-yr high of Rs 10.3 lakh crore

Why in the News

Banking system liquidity has climbed to a four-year high of about Rs 10.3 lakh crore on 3 September, its highest level since May 2022. The surplus is the direct product of the Reserve Bank of India’s (RBI) special US dollar-rupee forex swap facility, which drew foreign exchange inflows of $136.377 billion through 31 August. The RBI has closed that window ahead of schedule, leaving the swap usable only until 11 September. The tension is that an instrument run to defend the currency has produced a rupee overhang large enough to push overnight rates down at a moment when the Monetary Policy Committee expects headline inflation to peak. The central bank must now drain the surplus without triggering a sharp rise in interest rates or unsettling the government securities market.

How does the special dollar-rupee swap window work?

1. The transaction: Banks sell dollars to the RBI against rupees today, with an agreed reverse leg at a fixed future date, so the RBI takes the foreign exchange and releases rupees into the system.
2. Where the dollars came from: Banks raised them by mobilising Foreign Currency Non-Resident (Bank), or FCNR(B), deposits, which accounted for $127.226 billion of the total mobilisation.
3. The concession that made it attractive: The deposits were exempted from the Cash Reserve Ratio (the share of deposits a bank must park with the RBI) and the Statutory Liquidity Ratio (the share it must hold in specified securities), so the rupees released landed unencumbered.
4. The window’s closure: The deposit scheme ended on 31 August, and banks may use the dollar swap facility only until 11 September.

How large is the surplus, and how fast did it build?

1. The record: The liquidity surplus in the banking system hit a fresh record on 3 September, surpassing the previous high of Rs 9.7 lakh crore set a day earlier.
2. The pace of the build-up: The daily average surplus stood at Rs 3.67 lakh crore in August, more than three times July’s Rs 1.07 lakh crore.
3. The second source: Liquidity released through the RBI’s own foreign exchange operations added to the swap inflows, leaving a large pool of rupee funds chasing limited avenues for deployment.

Who raised the money?

1. Private banks took the largest share: Private sector lenders netted $61 billion, or 46.9 per cent of the $130 billion counted to 3 September.
2. Public sector banks came second: State-owned lenders raised $37 billion, a 28.5 per cent share.
3. Foreign banks took the remainder: Foreign lenders picked up $32 billion, or 24.6 per cent.
4. The tally is provisional: The final figure is likely to run higher once the data is fully captured.

Why is a surplus a problem for the central bank?

1. It drags the operating rate down: A large surplus puts downward pressure on the overnight money-market rate, including the repo rate, unless the RBI actively absorbs it.
2. It works against the inflation stance: Cheap overnight money can push inflation levels up, at a time when members of the Monetary Policy Committee have indicated that headline inflation is projected to peak as high as 5.9 per cent in Q3 2026-27 and that a case for a rate hike may emerge.
3. It runs against the global direction: Global central banks are keeping rates high or tightening cautiously, because inflation from energy and geopolitical shocks remains above target even as growth weakens.
4. The absorption itself carries risk: Draining the excess cannot be done in a way that triggers a sharp rise in interest rates or unsettles the government securities market.

What is the RBI doing about it?

1. It shut the window early: The swap scheme was stopped ahead of schedule. An official position two weeks earlier had stated there was no intention to do so.
2. It is absorbing through auctions: A 30-day variable rate reverse repo of Rs 7 lakh crore was announced on 4 September, an auction in which the RBI borrows surplus funds from banks for a fixed term at a market-determined rate.
3. A reserve requirement change is under discussion: Near-term options include a temporary Cash Reserve Ratio hike or the Incremental Cash Reserve Ratio first used in 2023.
4. One tool may not suffice: The assessment on record is that mopping up the surplus is a challenge and that the RBI may have to employ a range of liquidity absorption tools rather than one.

What could deepen or offset the surplus?

1. The projected peak: CareEdge Ratings expects core liquidity to rise from Rs 8.1 lakh crore as of mid-August to closer to Rs 13-14 lakh crore by December-end in the absence of liquidity management operations.
2. Festive currency demand pulls the other way: Currency in circulation could rise by around Rs 1.1 lakh crore from June levels by December during the festive season.
3. The forward book drains more: Maturing RBI short positions in the forwards market create an additional drag of around Rs 3 lakh crore, against a short-forward book maturing of $22 billion in three months.
4. Reserve accretion adds a smaller drain: Cash Reserve Ratio accretion on deposit growth should reduce core liquidity by a further Rs 70,000 crore.

What does the surplus do to bank funding?

1. Money market rates are already falling: Interest rates on certificates of deposit are declining as banks holding the new deposits stay away from bulk borrowings.
2. Large banks have saved on funding: The bigger banks are estimated to have saved about 25 to 60 basis points in incremental cost of deposits in August as they shed bulk funds.
3. The benefit spreads unevenly: Smaller banks and non-banking financial companies gain through cheaper money market funding, and the surplus itself is not evenly distributed among lenders.

Challenges to the special swap window

1. The inflow is debt and it matures: The deposits are repayable, so this year’s balance of payments gain converts into an outflow when they come due. Eg. Repayments begin in 2029, against a short forward book of $200 billion already lined up.
   The Fix: Build the repayment schedule into the reserve adequacy target and stagger maturities through a partial rollover window opened well before 2029.
2. Reversing the reserve exemption carries a credibility cost: Imposing a cash reserve requirement on deposits raised on an explicit exemption unwinds the term on which banks accepted the scheme. Eg. A temporary or incremental reserve ratio hike is among the absorption tools under discussion.
   The Fix: Exhaust longer tenor auction absorption before touching the exemption, and announce any change with a fixed sunset date.
3. The mobilisation is concentrated in a few balance sheets: Nearly half the money sits with private lenders, so both the funding advantage and the eventual repayment risk are clustered. Eg. Smaller lenders gain only indirectly, through cheaper money market rates.
   The Fix: Require bank-wise disclosure of the swap position and its maturity profile in the regulatory returns.
4. The scheme substitutes for structural inflows: A one-off deposit window fills the external account in a year when nothing has changed to attract durable foreign investment. Eg. A flight to safety in global markets would leave India unable to raise incremental inflows at any price.
   The Fix: Keep a standing, smaller swap facility open through the cycle, so mobilisation is not bunched into a single crisis window.

Conclusion

The RBI has ended one problem by creating its mirror image, and the currency defence now sits on the wrong side of the inflation mandate. The immediate marker is the outcome of the term absorption auctions and whether the reserve ratio is touched before the festive season drains currency out of the system on its own. The larger question opens at the far end of the deposit tenor, when the money raised in this window has to be sent back out. Every absorption tool used until then buys time rather than closing the external gap the window was opened to cover.

Back2Basics: Foreign Currency Non-Resident (Bank) deposit

1. What it is: A term deposit held with an Indian bank by a non-resident Indian or a person of Indian origin, denominated in a permitted foreign currency rather than in rupees.
2. Who carries the exchange risk: Principal and interest are repayable in the same foreign currency, so the depositor bears no rupee depreciation risk and the bank or the central bank carries it.
3. Tenor: Deposits are accepted for terms of one year to five years.
4. Regulation: The RBI sets ceilings on the interest rate banks may offer, fixed against a reference benchmark rate for the currency concerned.

Matching Previous Year Question

“[2010] When the Reserve Bank of India announces an increase of the Cash Reserve Ratio, what does it mean? (a) The commercial banks will have less money to lend (b) The Reserve Bank of India will have less money to lend (c) The Union government will have less money to lend (d) The commercial banks will have more money to lend (a)”