India’s banking system is currently flush with liquidity, supporting short-term interest rates and reinforcing the central bank’s growth-oriented stance, though conditions could tighten sharply in the second half of the fiscal year, a report by HDFC Bank said.
System liquidity averaged around Rs 4.0 lakh crore in April 2026, equivalent to roughly 1.2–1.3 per cent of net demand and time liabilities (NDTL), driven largely by seasonal factors such as year-end government spending and bond redemptions, the bank’s treasury research update revealed.
This surplus has pushed overnight borrowing costs closer to the lower bound of the policy corridor, with the weighted average call rate trading near 5 per cent, below the Reserve Bank of India’s repo rate. The central bank has so far refrained from aggressive liquidity absorption, signalling its preference to remain supportive of economic growth.
“The absence of more aggressive operations reflects the RBI’s tilt towards remaining growth supportive and tolerance towards the weighted average call money rate remaining comfortably below the policy rate,” HDFC Bank said.
The report expects liquidity to remain comfortable through August 2026, averaging around 1 per cent of NDTL, before moderating sharply in the second half of the fiscal year due to seasonal factors such as higher tax outflows and increased currency in circulation.
Liquidity could fall below 0.5 per cent of NDTL in the second half, potentially prompting further durable liquidity injections by the RBI through open market operations.
A key swing factor will be the central bank’s management of its forward foreign exchange book. Around USD 17 billion of short dollar positions are due to mature in the first quarter of FY27. If these are not rolled over, the system could face a liquidity drain of about Rs 1.6 lakh crore, accelerating tightening.
In such a scenario, liquidity levels could dip below 0.5 per cent of NDTL as early as the first quarter and turn negative by September, the report warned, adding that the RBI would likely intervene to offset the impact.
The outlook is also sensitive to global factors. Unsterilised foreign exchange intervention, sustained foreign investor outflows, or higher-than-expected currency in circulation could weigh on liquidity conditions. Conversely, improved risk sentiment and capital inflows could boost liquidity, with the RBI likely absorbing inflows to rebuild reserves.
On interest rates, the report noted that India’s yield curve has steepened since January, with surplus liquidity supporting short-term yields while longer-term yields remain elevated due to inflation concerns, global bond trends and foreign outflows.
This divergence is expected to persist in the near term. However, as liquidity tightens and inflation risks build, the yield curve is likely to flatten and shift higher in the second half of FY27.
HDFC Bank expects the benchmark 10-year government bond yield to move towards a range of 7–7.50 per cent during that period.
Despite rising inflation risks, the RBI is likely to remain on hold through calendar year 2026, the report said, noting that the central bank has room to “look through” temporary supply shocks unless they translate into sustained core inflation or broader inflation expectations.
Retail inflation is projected to average 4.9 per cent in FY27, with upside risks from potential El Niño conditions and persistent energy shocks.
Globally, markets are pricing in rate hikes by the Bank of Japan, European Central Bank and Bank of England, while the U.S. Federal Reserve is expected to remain on an extended pause, factors that could influence capital flows and domestic bond yields.
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