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Informist, Wednesday, Jan. 21, 2026

 

By Aaryan Khanna 

 

NEW DELHI – Liquidity is often described as the grease that makes the gears of the financial system turn. The truth of the old adage has been apparent in India's financial markets over the past month as corporate bonds, money market instruments, and even government securities feel the lack of cash in the hands of investors.

 

In January alone, the Reserve Bank of India has infused INR 1.0 trillion of durable liquidity through open market operation auctions as well as over INR 900 billion through a $10 billion, three-year dollar-rupee buy/sell swap auction. This is on the back of a nearly INR 2.0 trillion infusion through such means in December, which itself followed a 1 percentage point cut in cash reserve ratio that freed up around INR 2.4 trillion in liquidity for banks.

 

However, the net liquidity absorbed from the banking system by the RBI -- a proxy for the daily liquidity surplus -- was INR 721.31 billion Tuesday, less than 0.3% of the net demand and time liabilities of banks. Banking system liquidity may Wednesday end in a deficit as goods and services tax payments continue to drain liquidity, dealers said. The weighted average call rate -- the operating target of monetary policy -- has not been at or below the policy repo rate of 5.25% since Dec. 15.

 

Tuesday, the National Bank for Agriculture and Rural Development -- an all-India financial institution and a quasi-government body -- raised INR 100 billion through certificates of deposit maturing in one year at 7.22%. That is just below the yield on the Centre's 20-year bond and only around 20 basis points lower than coupon set on a new 50-year gilt on Friday. Yields on top rated three-month CDs have risen to 7.05-7.10% from 5.92-6.00% in the primary market since early December.

 

The 364-day Treasury bill cut-off rate at the auction Wednesday jumped up 9 basis points from the previous week to 5.72%, its highest since May 21. Mutual funds, the largest investor class in both instruments, said their liquid funds have not picked up any pace in January.

 

"Banks are the major contributors (to mutual fund inflows). We have not received the money from banks in the same quantum we had received prior to December," said Dwijendra Srivastava, executive vice-president and chief investment officer – debt at Sundaram Asset Management Co. "That is because they need money. If they need money, why would they put money back in a mutual fund?"

 

BANKS' CASH CONUNDRUM

Banks are choosing to use the funds for their own credit needs, especially with the lack of excess liquidity. Banks' annual credit growth as of Dec. 31 was at an over three-year high of 14.5%, with non-food credit disbursed topping INR 6 trillion during the final reporting fortnight of 2025. Deposit growth has not kept pace with credit, forcing lenders to resort to either raising short-term funds through certificates of deposit or liquidating their own investments for cash.

 

The government's income tax cuts in the Union Budget for 2025-26 (Apr-Mar) and GST cuts effective September likely acted as a trigger for consumption. Demand for credit has boomed during and after the festival season, supported by benign inflation and the Monetary Policy Committee's repo rate cuts between February and December 2025.

 

The RBI's series of OMO auctions have provided exactly that, delaying the impact of the liquidity crunch even as the credit-deposit ratio of the banking system has headed north of 80%, a record. Banks' growth in investments as on Dec. 31 was only 4.4%, despite double-digit deposit growth. Over and above this cash generation, banks are also expected to raise a large supply of CDs in the March quarter to raise money as credit growth is expected to remain healthy.

 

With the primary liquidity infusions by the RBI restricted to auctions, the liquidity surplus with banks is also concentrated in the hands of a few large institutions. For the remainder of the banking system, liquidity needs remain pressing and are a daily source of discomfort, dealers said. 

 

"When the RBI puts in liquidity through OMO auctions, the infusion only creates surplus in the hands of banks who have securities to participate. That creates friction in the money markets and keeps rates higher such that a bank requiring money may not have enough (limits) with the bank having surplus," said Alok Singh, head of treasury at CSB Bank. "Liquidity has also dried out in the banking system as the government may not have spent the money collected from advance tax and GST payments last month."

 

In addition to idiosyncratic government spending, another reason for the RBI's liquidity infusion not showing in the system is due to its own operations in the foreign exchange market. The consistent weakness in the rupee against the dollar has led the central bank to sell dollars in the spot market to support the domestic currency, part of its effort to curb excessive volatility. The daily sales of up to $2 billion drain rupee liquidity at a pace not matched by its sterilisation measures, either through dollar-rupee buy-sell auctions or similar interventions in the secondary market.

 

"The RBI is adding liquidity through one route and then taking it out equally through its FX (foreign exchange) operations," a senior treasury official at a state-owned bank said. "I would say that in December alone the RBI sold around $8 billion or $9 billion on a net basis in spot, and the pace would be higher for this month."

 

The RBI's foreign exchange assets were at a 10-month low of $550.87 billion as of Jan. 9, according to latest data. Despite the central bank's efforts, the rupee hit a record low of 91.7425 a dollar Wednesday. It has already depreciated over 1% in January against the greenback, making it likely that the central bank's intervention would continue, dealers said.

 

CORPORATE DEBT HIT

With poor liquidity as the trigger, the rise in CD rates has fed into two- and three- year corporate bond yields. This transmission led to losses for some investors, prompting withdrawals and further selling, which added to the stress across the corporate debt market. 

 

"The entire stress started with one-year CD rates moving up amid tight liquidity, which then pushed up corporate bond yields across short and medium tenors," a dealer at a mutual fund house said. "Some mutual funds faced redemptions and had no option but to sell in a shallow market."

 

NABARD's three-year AAA-rated paper yields jumped to 7.19% from 6.74?fore the December policy rate cut, given the 100-basis-point increase in the three-month CD rate in that period. Still, fund managers are looking to pounce and lock in current yields on CDs and commercial paper as they expect liquidity conditions to normalise within a few weeks.

 

"That said, most of the forced selling appears to be behind us, and at current levels there are buyers, especially in longer-tenure bonds," the mutual fund dealer quoted above said.

 

While the demand will eventually act as a balm to prevent rates moving higher, traders do not expect a reversal in CD rates or corporate bond yields at a time of large supply and seasonally tight liquidity near the financial year-end in March. One-year CD rates are looking attractive for a variety of mutual funds and they are looking forward to issuances in the tenure from banks, following the NABARD issuance setting a benchmark for the market, dealers said. On a fully hedged basis against the one-year overnight indexed swap rate, investors are still gaining a spread of over 160 bps. The spread is seen lucrative.

 

With the volatility in money markets continuing to play out, traders await further RBI measures on durable liquidity infusion. Expectations are around INR 1.5 trillion of liquidity infusion each in February and March at minimum, with around half of that likely to be wiped out by seasonal currency-in-circulation outflows, dealers said. The RBI will likely keep its mode of infusion the same, through open market bond purchases and dollar-rupee buy-sell swap auctions, they said.

 

"...fund managers have chosen to stay liquid rather than deploy aggressively, especially when yields were still adjusting upward," said Chirag Doshi, chief investment officer - Fixed Income Assets at LGT Wealth India. "Importantly, this does not indicate a cash shortage. In fact, mutual funds have been carrying higher-than-normal cash balances, preferring flexibility over incremental carry."  End

 

With inputs from J. Navya Sruthi, Cassandra Carvalho, and Vaishali Tyagi

Edited by Ashish Shirke

 

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