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Liquidity stress has re-emerged: deposit growth has stagnated despite a rebound in credit. Wholesale funding costs are rising, and CD-OIS spreads have widened. RBI share of money creation has (again) fallen sharply due to aggressive FX sales, driven by maturing forward shorts. These have offset CRR cuts, tightening durable liquidity – the Impossible Trinity at work. Deposits are also destroyed by growing currency demand (CIC) as the economy recovers and rising retained earnings in banks. With more forwards set to mature, and CIC likely to rise further, the RBI may need to inject more base money via OMOs. To sustain growth momentum, they may need to pre-empt the seasonal tightening of liquidity in 4Q.
Stress on deposits is back: CD-OIS widens again as RBI share of money falls
Despite a substantial (2.4pp) recovery in YoY credit growth from the bottom in May-2025, deposit growth has been unchanged. This has again started to push up the cost of liquidity (12M CD-OIS has rebounded to 110bps) and wholesale deposit rates. This is because RBI’s share of money-supply has shrunk by 1.2pp in the last four months, with its share of incremental money creation falling from ~23% to just ~11%.
Impossible trinity at work: effect of RBI FX interventions contrary to stance
As it decided to let an estimated US$24bn of FX forward sales mature, the RBI has had to sell about US$33bn over the 18 weeks from 23-Jun to 17-Oct. This led to liquidity destruction of ~Rs2.8tn, more than offsetting the Rs1.3tn released by 50bps of CRR cuts, bringing outstanding durable liquidity down to 1.5% of NDTL, and net liquidity to neutral. Another USD15 bn of FX sales could offset the impact of CRR cuts scheduled in Nov.
Deposit ‘destruction’ is adding to the pressure on wholesale funding rates
With the cyclical headwinds emerging from a higher-than-reported fiscal consolidation in FY25 and the policy-engineered sharp slowdown in credit growth now receding, economic momentum is improving. This has increased demand for currency in circulation (CIC). Further, higher bank profits also destroy deposits: on the combined banking system balance sheet, liabilities effectively shift from deposits to equity.
While RBI letting the INR move helps, base money injections still need to rise
With the RBI allowing the INR to move again in the last two days, liquidity drain from FX sales should slow, but US$30bn of forward shorts are estimated to mature by Mar-2026. With CIC expected to grow by another Rs1tn, it would be prudent to inject base-money via Open Market Operations even before liquidity conditions tighten seasonally in 4Q; Rs2tn-plus may be needed. Given the high equity base, the system should also be comfortable with high LDRs.
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