India's banking liquidity surplus hits ₹10.5 trillion after record diaspora inflows

India's banking system is awash with liquidity after a record $127 billion flowed in from the country's vast diaspora through a special programme.

The dollar inflows have pushed surplus liquidity in the banking system to nearly ₹10.5 trillion, an all-time high, Bloomberg reported on Monday.

The surge has also driven the overnight rate below the Reserve Bank of India's benchmark rate, complicating the central bank’s monetary policy objectives.

The $127 billion raised through the programme far surpassed estimates. The excess liquidity is now expected to force the RBI to step up efforts to absorb funds from the banking system.

BT Explainer: What is VRRR auction and why is it key to RBI’s liquidity management post FCNR (B) boost?

"The RBI is likely to step up liquidity absorption," Barclays Bank economists wrote in a note, according to Bloomberg. "We expect a mix of continued variable reverse repo rate ops (VRRRs), and an incremental cash reserve ratio hike (ICRR) to be deployed."

They added that "an increase in currency in circulation in the festive period (September-November) and FX interventions will also take out liquidity".

However, Barclays does not expect the RBI to use permanent liquidity absorption tools in October. "We do not expect permanent liquidity absorption tools such as CRR hike (without a sunset clause), OMO sales, MSS or a policy rate hike in October," the economists said.

Don't Miss: FCNR deposit bonanza: Economists explain why deft liquidity management will be key

'Surfeit Of Rupee Liquidity'

Suyash Choudhary, CIO for fixed income at Bandhan AMC, said the RBI may need to act soon.

"RBI may have to deploy a combination of temporary and more permanent measures for liquidity absorption, and sooner rather than later," Choudhary wrote in a note.

"The heavy FCNR flow has led to a surfeit of rupee liquidity that has pulled down average overnight rates to much below policy rates, and generally loosened money market conditions towards recent extremes," he said.

The eventual adjustment will depend on how quickly the RBI normalises liquidity conditions. The CIO said the process would begin with restoring the overnight rate as the anchor for policy rates, followed by measures to absorb medium-term excess liquidity.

"This involves a series of steps starting first with re-fixing overnight rate anchor to policy rates, then to think about how to absorb the medium-term excess liquidity, even as the MPC contemplates the pace of repo rate normalization given rising inflation pressures," he said.