RBI’s liquidity balancing act: For much of September, the banking system had a problem that may sound like a happy one to some: too much liquidity. The surplus had touched a record ₹11.16 trillion in the first week of September. By September 21, it had fallen to about ₹4.9 trillion as the Reserve Bank of India absorbed cash through bond sales and other operations, while GST payments also drained funds from banks.
The more interesting development is what has happened to the overnight call money rate, the rate at which banks lend to one another for very short periods. The weighted average call rate rose from 4.92% to 5.24% on Monday and then to 5.31% on Tuesday, moving above the RBI’s 5.25% repo rate for the first time in nearly two months. The call rate is the key operating target through which monetary policy conditions are transmitted to the financial system.
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The movement suggests that the RBI’s liquidity operations have begun to restore the link between its policy rate and conditions in the money market. But the task is becoming more complicated. The central bank has to absorb a large and relatively durable liquidity injection while avoiding unnecessary pressure on a government bond market that already faces substantial borrowing.
How banks ended up with surplus liquidity
The unusual liquidity surplus was triggered largely by the RBI’s special foreign-exchange mobilisation measures introduced in June. The concessional forex swap facility, operationalised on June 8, attracted more than $143.5 billion of inflows by September 18. FCNR(B) deposits accounted for nearly $133 billion of the total, with overseas foreign-currency borrowings and external commercial borrowings making up the rest.
The mechanism matters. Banks mobilised foreign-currency funds and entered into swaps with the RBI, receiving rupee liquidity in return. That increased the amount of rupee cash available to the banking system. The RBI can subsequently absorb this liquidity through its monetary and foreign-exchange operations, but a large inflow can leave banks with substantially more cash than they need at a particular point in time.
That is what happened in September. The RBI initially relied heavily on variable-rate reverse repo auctions, under which banks park surplus funds with the central bank for a specified period. On September 15, the RBI absorbed ₹3.93 trillion through one such auction. It subsequently used further VRRR operations as the liquidity surplus remained high.
Temporary operations, however, are not always sufficient when the liquidity injection is expected to persist. If money leaves the banking system because of a tax payment or a government transaction, it can return when the government spends. A more durable injection requires a more durable response.
That is where open market operations, or OMOs, come in. In an OMO sale, the RBI sells government securities to banks and other investors. The buyers pay for the securities, and the corresponding rupees leave the banking system. Unlike a reverse repo operation, the liquidity does not automatically return when the transaction matures.
The RBI announced OMO sales totalling ₹1 trillion in September. It sold ₹50,000 crore on September 17 and another ₹25,000 crore on September 21, with the remaining ₹25,000 crore scheduled for September 28. The second auction attracted bids substantially above the notified amount, indicating strong demand for the securities despite the additional supply.
GST-related outflows have added to the absorption of liquidity. Together, these operations have brought the surplus down sharply from its September peak.
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Liquidity balancing: The call rate is the clearest signal
The decline in liquidity matters because an excess of cash can push overnight interest rates below the level intended by the RBI. Banks with large cash surpluses have less reason to borrow from one another, putting downward pressure on money-market rates.
If that happens on a sustained basis, the policy repo rate becomes a less effective signal for other interest rates in the financial system. The transmission of monetary policy depends partly on the overnight market rate responding to changes in the policy rate.
The recent rise in the call rate therefore provides a useful measure of the RBI’s progress. On September 21, the weighted average call rate was 5.24%, almost exactly at the 5.25% repo rate. On September 22, it rose to 5.31%, slightly above the policy rate as liquidity fell below ₹5 trillion.
That does not mean the liquidity issue has been permanently resolved. Government spending, tax payments, currency demand and capital flows can alter banking-system liquidity from one week to another. The RBI itself will have to judge how much of the current surplus is temporary and how much represents a more durable increase in system liquidity.
There is also a distinction between surplus liquidity and excessive credit. A banking system flush with cash does not automatically mean households and companies will borrow more. Credit demand, banks’ risk appetite and the financial condition of borrowers determine how much of that liquidity turns into loans.
The bond market is the next constraint
The RBI’s use of OMOs creates another policy complication because the government is already a large issuer of bonds.
The Centre’s gross market borrowing requirement for 2026-27 was initially set at ₹17.2 trillion. After debt switches, it was reduced to ₹16.09 trillion, of which ₹8.2 trillion was scheduled for the first half of the financial year.
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The second half will bring another substantial supply of government securities. Market estimates put the combined net supply of central government securities and state development loans at about ₹12.5 trillion in the second half of FY27, compared with roughly ₹9.2 trillion in the first half.
This creates a difficult interaction between liquidity management and debt management. The government needs investors to absorb its borrowing, while the RBI is selling government securities to withdraw surplus cash from banks. The two operations serve different purposes, but they draw on the same pool of investors.
If bond supply remains heavy, investors may demand higher yields to absorb additional securities. The 10-year government bond yield was around 7.05% on September 21, and market participants have indicated that it could move towards 7-7.25% if supply remains heavy, global yields stay elevated and domestic monetary conditions tighten.
That possibility places a limit on how aggressively the RBI can rely on bond sales as its liquidity tool. The central bank has to consider not only whether excess cash is being removed from banks, but also what its operations are doing to the price of government debt.
The September episode therefore illustrates a broader problem in monetary management. A large liquidity injection can originate in one part of the central bank’s balance sheet and create consequences in another part of the financial system. The RBI’s foreign-exchange operation helped bring dollars into the banking system and supplied banks with rupees. The subsequent withdrawal of those rupees is now affecting overnight rates and the government bond market.
The immediate objective is clear enough: prevent surplus liquidity from keeping money-market rates materially below the repo rate. The harder task is to do so without tightening financial conditions unnecessarily or adding to the pressure on government borrowing costs.
The RBI has already brought the liquidity surplus down sharply. Whether it needs to go much further will depend on how much of the remaining surplus persists after government and tax flows settle. That judgement will determine whether the next phase of liquidity management is primarily about draining cash or about avoiding an excessive squeeze on the bond market.