As of 6 April 2026, the banking system was in a liquidity surplus of about Rs 3.8 trillion. This is a reasonably comfortable headline number, equivalent to roughly 1.5% of banks’ net demand and time liabilities (NDTL).
Yet, this headline surplus masks a much more uneasy underlying reality. Despite sustained and historically large liquidity injections by the Reserve Bank of India (RBI), funding conditions have tightened steadily through FY26. Short-term rates have risen sharply, deposit growth continues to trail credit growth, and banks’ marginal cost of funds has increased even though the policy repo rate has remained unchanged.
To understand this apparent contradiction, it is useful to look beyond point-in-time liquidity numbers and examine trends, composition and the forces draining liquidity from the system.
Looking at averages, not snapshots
Banking system liquidity has a well-known intra-month pattern. Liquidity is usually more comfortable in the first and last weeks of the month, supported by government spending, and tightens in the second and third weeks as tax outflows peak. As a result, snapshots can be misleading.
On a monthly average basis, liquidity conditions did improve in February and March 2026. System liquidity averaged around Rs 2 trillion during these months—about 0.8% of NDTL—compared to just Rs 600 billion in December 2025 and January 2026.
Even so, this “improvement” needs to be seen in context. For the past 16 months, since December 2024, the RBI has had to expend considerable effort simply to keep liquidity conditions from slipping into a deep and persistent deficit. In the absence of these interventions, the banking system would almost certainly have been facing a severe shortage of funds.
A historic scale of liquidity infusion
Between December 2024 and March 2026—a span of just 16 months—the RBI undertook permanent liquidity injections of approximately Rs 19.7 trillion. Looking at FY26 alone, net liquidity infusion amounted to Rs 13.5 trillion, a historically unprecedented scale.
For comparison, even during the Covid period, total liquidity infusion was of the order of Rs 10 trillion. These measures were deployed across multiple instruments. Outright government bond purchases injected Rs 8.8 trillion in FY26, with Rs 6.4 trillion conducted between November 2025 and March 2026 alone. A reduction in the cash reserve ratio (CRR) freed up around Rs 2.5 trillion of durable liquidity. Foreign exchange buy–sell swaps, worth about Rs 2.3 trillion in FY26, involved the RBI buying dollars upfront—injecting rupee liquidity—with an agreement to reverse the transaction in subsequent years. In addition, the RBI relied on longer-tenor variable rate repo and reverse repo operations to smooth short-term liquidity friction.
Taken together, these interventions represent one of the most aggressive liquidity support phases in India’s monetary history. This raises a natural question: Why was such a massive infusion necessary just to maintain marginal surplus liquidity?
What drained liquidity?
One factor was elevated currency leakage. Currency withdrawals by the public in FY26 were nearly double those of FY25 and around Rs 1 trillion higher than the trend of the previous four years. This mechanically drains liquidity from the banking system.
However, currency leakage alone does not explain the scale of stress. The more fundamental issue was sustained dollar outflows and speculative dollar demand, driven by negative sentiment around the rupee. India witnessed net dollar capital outflows in FY26—the first such episode since FY1973—and is likely to record a balance of payments deficit for a second consecutive year.
As the RBI intervened in the foreign exchange market to smooth volatility and counter one-sided expectations, rupee liquidity was drained. While FX swaps partially offset this drain, they also shifted liquidity stress into future periods when these swaps mature.
In short, pressure on the external account became the key driver of domestic liquidity tightness.
Why funding costs rose despite a steady repo rate
The impact of tight liquidity has been most visible in money market rates. Three-month certificate of deposit (CD) rates—a good proxy for banks’ short-term funding costs—rose from around 5.8% in August–October 2025 to over 7.55% by March 2026. That is an increase of 170 basis points without any change in the policy repo rate. Equally striking is the widening spread over Treasury bills. The CD–T-bill spread expanded from 30–40 bps during September 2025 to nearly 215 bps by March 2026—levels higher than even those seen during the IL&FS-led credit stress episode.
Structural balance sheet pressures have amplified this problem. Deposit growth is lagging credit growth by about 3.5 percentage points. The incremental credit-deposit ratio stood at 104% at the end of FY26, while the overall credit-deposit ratio reached 83%. Historically, ratios above 75% have been associated with rising funding stress. The result is that even with “surplus” system liquidity on paper, banks continue to experience tight marginal funding conditions.
What could ease liquidity stress?
There are few durable solutions. First, a slowdown in credit demand would reduce pressure on bank funding. However, this is neither assured nor necessarily desirable for growth. Second, the government consistently maintains cash balances of Rs 2 trillion or more. A drawdown of these balances would recycle liquidity back into the banking system, offering partial relief. The most crucial factor, however, is the return of foreign capital. Without a sustained improvement in capital inflows and balance of payments dynamics, domestic liquidity conditions will remain hostage to external pressures.
Unless these forces change meaningfully, the RBI may have little choice but to continue liquidity infusion into FY27—not to stimulate credit, but simply to prevent a further sharp rise in the cost of funds and avoid a deeper tightening of financial conditions. In that sense, India’s liquidity problem today is not about excess money. It is about a system struggling to find stable, durable funding in an increasingly uncertain global and domestic environment.
The author is a CFA, Chief Economist, SBI Mutual Fund.
