With India’s system liquidity hitting a surplus of Rs 11.16 lakh crore, and inflation looming over the Reserve Bank of India’s target, the central bank’s money market operations are now in high focus.
Following higher than forecasted inflows through its special schemes, the banking system mobilised $136.4 billion of foreign currency inflows, including $127.2 billion through the FCNR (B) window, $5.3 billion via the overseas foreign currency borrowings (OFCBs), and $3.9 billion through external commercial borrowings (ECBs).
According to a report published by Union Bank of India (UBI), these inflows are expected to total $147 billion by the end of December, as the bank expects inflows through the ECB and OFCB routes to reach $10 billion by the end of their tenure.
Additionally, India’s foreign exchange reserves have also climbed to a record high of $729.3 billion, and over the previous sessions, the domestic unit’s trading range has narrowed sharply despite elevated crude prices and geopolitical uncertainties.
With foreign currency flooding the banking system, the conversation now centres around liquidity management and what tools the RBI will deploy to counter the challenges as the core liquidity nears the double-digit mark.
How much surplus liquidity is building up?
According to data cited in UBI’s report, core liquidity increased to Rs 8.05 lakh crore by mid-August, from Rs 4.82 lakh crore in mid-June. The bank notes that the liquidity expansion was predominantly led by the net FX impact, which brought in Rs 3.08 lakh crore.
Other secondary factors, such as currency circulation, added around Rs 0.27 lakh crore, while the Cash Reserve Ratio absorbed Rs 0.12 crore. Under an illustrative model, the bank forecast that core liquidity could reach Rs 14.17 lakh crore by mid-September.
That is a lot of surplus rupees to manage. The RBI’s stated objective is to keep the weighted average call rate (WACR) close to the policy repo rate, currently 5.25%. As RBI Governor Sanjay Malhotra signalled at the August policy review, the main tools used so far have been 2-way operations, largely short-term variable rate reverse repo (VRRR) auctions.
However, these instruments haven’t been successful in aligning the call rate with the repo rate. Taking the most recent instance, RBI carried out two VRRR auctions on September 7, which mopped up Rs 6.12 lakh crore from the banking system but were undersubscribed.
The central bank’s first VRRR auction of Rs 7 lakh crore with a tenor of 30 days saw an underwhelming response, receiving bids for Rs 2.59 lakh crore, which were accepted at the cut-off and WACR of 5.24%, according to RBI data. Immediately after this, an overnight auction of Rs 5 lakh crore was announced.
While the short-tenor VRRR saw better response, attracting Rs 3.53 lakh crore in bids, the auction was not fully subscribed, reflecting that the RBI will have to deploy more tools to absorb the excessive liquidity.
According to UBI, given the sharp positive rise in FX inflows, durable liquidity measures are likely to be announced before October’s policy meeting. UBI notes that alongside these long- and short-tenor VRRR/ Standing Deposit Facility (SDF), there’s a high probability that the central bank may opt for an Incremental Cash Reserve Ratio. (I-CRR).
Here’s a list of the instruments UBI notes are most and least likely to be used by RBI, according to UBI.
RBI’s liquidity toolkit ranked by likelihood
| Tool | What it does | Probability of use |
| SDF / short-tenor VRRR | Rolling, short-term cash absorption; fast and flexible | High (already used once) |
| Longer-tenor VRRR | Locks up surplus for longer where the glut persists | High (already used once) |
| Incremental CRR (I-CRR) | Temporary, targeted lock-up tied to FCNR(B) deposits | High |
| FX forward maturities | Runs down RBI’s existing short-term forward book | Medium |
| USD/INR Sell-Buy swaps | Mops up liquidity tied directly to FX purchases | Medium |
| OMO Sales | Durable absorption, but pressures bond yields | Medium |
| CRR hike | Immediate and durable; often doubles as a precursor to rate hikes | Medium |
| MSS (Market Stabilisation Scheme) | Durable absorption, but carries a fiscal cost | Low |
Source: RBI, Union Bank of India research
What are the drawbacks of each liquidity tool?
UBI notes that high-probability tools like SDF, overnight VRRR, or short-tenor VRRR need constant monitoring, while Longer-tenor VRRR, which is appropriate for extending liquidity lockup, has a flip side to it given the busy season for banks.
Talking on I-CRR, UBI notes that while this tool helps with liquidity lock-up, its downside comes as the instrument penalises lenders that received higher flows under the swap scheme with a CRR exemption initially given on the same deposits. This was last deployed by the central bank in FY23-24.
Medium-probability usage instruments like FX forward maturities carry the disadvantage of limit capping, while USD/INR Sell-Buy Swaps bring upward pressure to Fwd premia, which is negative for hedging activity.
UBI notes that RBI may consider OMO sales for short-term bonds before hiking rates, despite the instrument’s upward pressure on bond yields. Although the CRR hike is marked as durable by UBI, the tool, if deployed, may get cost-heavy for lenders and could also penalise banks that did not acquire adequate deposit flows.
At the bottom of the list is the Market Stabilisation Scheme (MSS), last used after demonetisation in 2016, seen as unlikely now that the SDF exists as a cheaper alternative.
How could the RBI absorb the projected Rs 14.17 lakh crore surplus?
| Bucket | Tool | Estimated amount (Rs lakh crore) |
| Temporary / reversible | Short-tenor VRRR | 7.09 |
| Longer-duration | Long-tenor VRRR | 2-3 |
| Longer-duration | Incremental CRR (0.5-1% of NDTL) | 1.25-2 |
| Longer-duration | FX sell-buy swaps | 1-2 |
| Longer-duration | OMO bond sales | 1-2 |
Source: RBI, CEIC, Union Bank of India research
According to UBI, the forecasted Rs 14.17 lakh crore surplus can be absorbed by the central bank through a 50:50 mix. The bank suggests using short-tenor VRRR auctions for quick absorption of Rs 7.09 lakh crore as these instruments are of temporary and reversible nature. Their deployment is suggested given the long credit season of H2.
As for the remaining Rs 7.09 lakh crore, UBI notes that longer-duration tools like incremental CRR, OMO bond sale, and FX swaps should be deployed gradually only after accounting for the natural liquidity drawdown from H2 credit growth.
Could the liquidity glut trigger a rate-hike cycle?
The liquidity surplus could eventually affect the RBI’s rate hike cycle too, as UBI expects the central bank to start increasing its rates in H2 FY27, which have been unchanged at 5.25% since December 2025. This comes amid hawkish minutes from August’s Monterey Policy Committee (MPC) meeting alongside strong economic growth and inflation remaining above the RBI’s target for two consecutive months.
According to UBI, December is more likely to be the starting point for RBI’s rate-hike cycle. However, the bank expects this to be mild, expecting only two or three increases of 25 basis points each, potentially taking the repo rate within the 5.75%-6.00% range.
However, UBI flags that the timing might change if the US Federal Reserve hikes rates in September. This could prompt the central bank to keep a more hawkish stance and will increase the likelihood of a rate hike in October, although UBI expects liquidity absorption to be underway before the tightening begins.
Elevated crude prices remain a key risk, and a sustained increase above $90 per barrel will keep mounting inflationary pressure and weigh on the rupee. On the other hand, if geopolitical tensions fizzle out, the RBI may delay or avoid hiking rates aggressively.