The Reserve Bank of India has used dollar-rupee sell-buy swaps, spot dollar sales, bond sales and variable-rate reverse repos in recent weeks to reduce excess liquidity, according to bankers and economists cited by Reuters. The measures, combined with tax outflows, have more than halved the banking system's liquidity surplus from a record 11.16 trillion rupees earlier this month.
Core liquidity, which provides a measure of the more persistent surplus after excluding daily fluctuations in cash balances, fell to 11.5 trillion rupees from 14.2 trillion rupees on September 4, according to Gaura Sengupta, chief economist at IDFC First Bank.
Sengupta estimated that RBI net dollar sales of about $18.5 billion through spot transactions and sell-buy swaps, alongside bond sales, had driven much of the decline. Economists expect additional liquidity could be removed through further bond sales and foreign-exchange swaps.
The central bank's approach reflects the scale of surplus liquidity facing India's financial system. Excess cash can place downward pressure on short-term borrowing costs and complicate efforts to manage inflation, particularly at a time when higher global energy prices are increasing risks to domestic price stability.
Foreign-exchange operations have also affected the cost of hedging. The RBI's sell-buy swaps have pushed dollar-rupee forward premiums higher, with the one-year premium rising by about 50 basis points during September, according to Reuters.
The central bank has previously indicated that it has several tools available to manage liquidity, including bond sales and foreign-exchange swaps. Governor Sanjay Malhotra has signalled that these instruments could be used instead of relying primarily on changes to cash reserve requirements.
For banks, tighter surplus liquidity could gradually alter money-market conditions and increase the cost of some forms of short-term funding. For companies, changes in liquidity conditions could influence borrowing costs and access to domestic credit.
The RBI is therefore balancing two objectives: reducing excess liquidity that could complicate monetary management while avoiding a withdrawal of funds large enough to disrupt economic activity.
The effectiveness of the approach will depend on how quickly liquidity conditions normalise and whether inflationary pressures from energy prices require further monetary adjustment.
