Why RBI's Liquidity Flood Could Hide a Credit Crunch: What Investors Must Watch

• RBI poured over Rs 17.7 trn of liquidity by early Feb 2026, yet system liquidity is only 0.6% of NDTL.
• Money‑market spreads have exploded from ~35 bps to ~170 bps, signaling acute stress.
• FX buy‑sell swaps withdrew an estimated Rs 9.2 trn, outweighing the benefits of higher reserves.
• Net FDI collapsed to $1 bn in FY25, dragging the current‑account deficit and rupee depreciation.
• Investors face a fork: a bounce‑back from the pending trade deal or a deeper credit squeeze.

Most investors missed the fine print in RBI’s liquidity blitz – that was a costly mistake.

RBI’s Growth‑First Pivot: What Changed?

At the start of 2025 the Reserve Bank of India deliberately turned its back on the inflation‑centric stance that had defined the previous decade. Instead, it embraced a growth‑first mantra, launching a multi‑month easing programme in December 2024. The toolkit included policy‑rate cuts, large‑scale open‑market operations (OMOs), a cut in the cash‑reserve ratio (CRR), and a flurry of foreign‑exchange (FX) buy‑sell swaps. The explicit goal: super‑charge credit creation and revive a sluggish domestic economy.

Scale of Liquidity Injection and Its Real Impact

By 30 January 2026 the RBI had injected Rs 16.3 trn of liquidity, followed by an extra Rs 1.4 trn in the first week of February. The bulk arrived through three channels:

• OMOs – outright purchases of government securities totaling Rs 6.7 trn, which represent roughly 61 % of the net G‑sec supply for FY26.
• CRR reduction – freeing up bank reserves so that a larger slice of net demand and time liabilities (NDTL) can be turned into loans.
• FX buy‑sell swaps – the RBI buys dollars today, injecting rupees, and promises to reverse the trade within three years.

Despite the headline‑grabbing volume, the banking system’s liquid assets stood at only Rs 1.5 trn – a mere 0.6 % of NDTL. In a typical easing cycle, analysts look for at least 1 % of NDTL to be freely available, a benchmark the Indian system missed by a wide margin.

Why System Liquidity Remains Shockingly Low

The shortfall is not just a statistical quirk; it reflects structural drains:

• Government cash hoarding: The central and state governments keep between Rs 1.5 trn and Rs 4 trn idle each day, averaging Rs 2.5 trn. Because the RBI acts as their banker, this cash is effectively pulled out of the commercial‑bank pool.
• Durable liquidity adjustment: Analysts strip out government cash to gauge “durable” liquidity. Even after this adjustment, the net excess is only Rs 3.5 trn above the level 14 months earlier – insufficient to ease stress.
• Physical cash withdrawals: Over the past 14 months, the public withdrew Rs 4.4 trn in notes, three times the pace of the same period last year, even as digital payments grew 14 % YoY.
• Regulatory CRR requirements: With NDTL expanding at 11‑12 % annually, banks must park a growing amount of funds with the RBI, a neutral but liquidity‑consuming effect.

The net result? Money‑market spreads over Treasury bills have widened from a modest 30‑40 bps to nearly 170 bps, a clear market signal that borrowers are paying a premium for scarce cash.

FX Operations, Reserves, and the Rupee Drag

At first glance India’s foreign‑exchange reserves look robust – peaking at $724 bn in the last week of January 2026. However, a deeper look reveals a paradox:

• Foreign‑currency assets fell by $54 bn since September 2024.
• Gold holdings rose by $72 bn, offsetting the currency loss.
• The forward‑book liability grew by $49 bn, meaning future outflows are already booked.

When the forward obligations are netted, effective reserves shrink to roughly $650 bn. Meanwhile, the RBI’s spot FX swaps have sucked an estimated Rs 9.2 trn out of the banking system – a magnitude far exceeding the headline reserve gain.

Rupee sentiment has turned sour. The currency’s depreciation pressure, amplified by a steep fall in net FDI (from $30 bn annually in FY15‑22 to just $1 bn in FY25), has forced the RBI to intervene repeatedly, draining domestic liquidity.

Implications for Corporate and Government Bond Markets

Higher money‑market rates ripple through the broader fixed‑income arena. As banks scramble for cash, they raise the yields they demand on corporate and sovereign bonds. The spread between 10‑year government bonds and Treasury bills, which previously hovered around 150 bps, is now nudging the 200 bps territory.

Sector‑wise, export‑oriented companies and those with dollar‑linked debt are hit hardest. The weakening rupee raises the local‑currency cost of servicing foreign‑currency loans, a risk that has already prompted credit‑rating agencies to flag several mid‑cap firms.

Meanwhile, peers such as Tata Group and Adani are navigating the same liquidity squeeze but have different exposure profiles. Tata’s diversified export base and sizable internal cash buffers cushion it, whereas Adani’s capital‑intensive projects and higher leverage make it more vulnerable to a credit crunch.

Investor Playbook: Bull vs Bear Scenarios

Bull case: The pending trade agreement with the United States and Europe could revive FII inflows, stabilize the rupee, and improve the current‑account balance. If the RBI trims FX swaps and the government reduces its cash hoarding, durable liquidity could climb above 1 % of NDTL, compressing money‑market spreads and lowering bond yields. In that environment, Indian equities – especially banks and export‑driven manufacturers – could see a fresh rally.

Bear case: If FDI remains muted and the trade deal stalls, the RBI may be forced to continue aggressive FX swaps, further draining liquidity. Persistent high spreads would pressure corporate earnings, trigger downgrades, and push bond yields to multi‑year highs. A prolonged credit squeeze could also spark non‑performing asset (NPA) build‑up, reviving concerns about asset quality.

For investors, the key actions are:

• Monitor money‑market spreads (especially the T‑bill + 170 bps level) as an early warning of liquidity stress.
• Track RBI’s weekly OMO and FX‑swap announcements – a rise suggests deeper stress.
• Prefer companies with strong cash flows, low foreign‑currency debt, and diversified export markets.
• Consider short‑duration sovereign bond exposure to hedge against a potential yield spike.

In a landscape where headline liquidity looks abundant but real‑world cash is scarce, the smartest investors will read between the lines and position for both the upside of a trade‑deal‑driven recovery and the downside of a hidden credit crunch.