RBI’s ₹1.5 trillion booster package: A critical analysis on the impact over Indian Economy

 

On 28th of January, 2025 the prime-time business column of the Business Standard read as follows- “RBI to inject 1.5 trillion dollars into the economy. Markets rebound and the road ahead”. As students of economics, finance and enthusiasts of international relations; we found this as an opportunity to apply the theoretical knowledge acquired so far and apply them in this situation. Through this article, we aim to present a detailed and critical analysis of this phenomenon of liquidity injection and its impact on the world's fastest growing economy - India.

RBI’s Liquidity Injection Phenomenon - The 4 W's 

 

Using the 4 W's framework we can gain an in-depth understanding on the what, when, why and how of this move as under:

 

The WHATs-

 

The Reserve Bank of India (RBI) has announced special measures to improve liquidity conditions in the banking system.It is expected that ₹1.5 trillion (approx. $18 bn) would be injected in the system. This comes in connection with the ‘pro-people and pro-developmental stance’ of the government ahead of the monetary policy meeting with RBI.  

 

As of Q-3 2024-25, our systemic liquidity registered a deficit of ₹1.2 trillion. This was mainly due to excess tax outflows along with depletion of forex reserves.Additionally, commercial banks also borrowed ₹1.4 trillion daily from the RBI’s repo window. This posed several constraints in systematic liquidity.

 

Furthermore, India’s current account deficit stood at 1.2% of GDP, Q2, FY25. Also, dependence on foreign capital for investment and energy requirements makes it vulnerable to external shocks. Hence, RBI aims to inject liquidity in the economy at a rate of 6.75% which is higher than the existing short term lending rate (repo rate) at 6.5%. 

Doing this will not only ease liquidity constraints but also stabilize the short term shocks in the markets. 

 

The WHENs-

The RBI announced this policy when the liquidity gap increased the burden on manufacturing, real estate and infrastructure sectors as they are credit intensive. Due to liquidity constraints, banks may adopt a stringent ‘selective credit control policy’. Thus, due to higher interest rates and fund constraints, economic explosion will experience a break. Through this booster (December

2024-January 2025) the RBI ensures that banks can continue lending at reasonable interest rates and prevent credit slowdowns. This is the second time, RBI is infusing liquidity in such huge amounts after December 2023.

 

On 3rd December, 2023, the RBI began this exercise by reducing Cash Reserve Ratio (CRR) from

4.5% to 4%. After that, the following measures were implemented:

●       RBI injected ₹20,000 crore into the system through open market operations by lowering the 10-year bond yield from 7.25% to 7.15%.

●       After that, it reduced the 3-month Treasury Bill yield from 6.75% to 6.50%. This injected ₹10,000 crores into the economy.

●       To keep the 10-year bond yield steady at a rate of 7.05%; RBI bought foreign currency reserves to stabilize the rupee.

●       RBI extended the long-term Marginal Standing Facility (MSF);  causing the 6-month Treasury Bill yield to drop from 6.60% to 6.45%.

●       Lastly, Sensex rose 2-3% over December,2023. owing to a positive market sentiment.

 

The WHYs-

 

The underlying cause behind this move are highlighted as under:

Liquidity tightening to curb inflation

The CPI inflation rose to 5.7% YoY in December 2023 against the 4% target rate. Additionally, the prices of food items and staples rose at a higher rate than other goods of the basket. While the similar step taken by RBI in December 2023 led to tightening liquidity, further injection avoids such situations. Keeping the ever-increasing GDP Growth rate curve of India, liquidity injection may enable us to attain the projected rate of 6.5% (Q3, FY25)

 

Addressing the ‘liquidity gap’

Liquidity gap occurs when the rate of outflows exceeds the rate of subsequent inflows. In December 2024, it was reported that India sold forex reserves amounting to a whopping $50 billions. To the contrary, private capex on developmental projects remains sluggish. This is primarily due to higher borrowing costs and tighter short-term interest rates for developmental projects by the private sector. However, credit growth to industry started rebounding and stood at 8.3% YoY as of December 2024.

 

Addressing securities market volatility 

Capital outflows and rising U.S. Fed rates created liquidity constraints. This not only created liquidity stress but also blocked smooth credit flow. 10-year G-Sec yields surged to 7.25% in December 2024 (vs. 7.1% in December 2023). This increased the borrowing costs. Thus, RBI aims to ease pressure ahead of FY25 borrowing calendar.  Not only that, liquidity injection is also important to offset dollar sales given that $1=₹ 87.23 already.

 

Positive impact on investment vehicles

When RBI injects liquidity through short term interest rates, the borrowing costs reduces. Due to this, INVITS (infrastructure investment funds) that operate on a debt-equity mix are able to pool in more funds, thus, increasing profitability. Additionally, this will lead to yield compression. In a scenario of lower yield rates, investors will prefer stability over price. This will indirectly increase the demand for INVITS instruments, leading to their price hikes. As mentioned above, INVITS operate on a debt-equity mix, hence the impact on debt and equity remains similar.

 

Leverage higher yields on investment vehicles 

A point to be noted, that, during the recent liquidity injection exercise in 2023, the returns of popular InVITS like IndiGrid, IRB Infrastructure Trusts stood at 8-10%. Thus, another liquidity injection may lead to another similar YoY return to the investors, given the fact that green finance initiatives have surged the capital base of IndiGrid by around 50%. Furthermore, energy stocks like TATA POWER showed an impressive CAGR of 23.4%. The demand for green bonds also rose post liquidity injection.

 

 

The HOWs:

The multi-pronged approach to manage liquidity involves three instruments - CRR, OMO and 56 days VRR. The three major steps would be as under:

1.      Open market operations: By purchasing G-Secs, RBI aims to pump ₹60,000 crores into the economy. It will be done in 3 phases i.e. 30th January, 13th February and 20th February,2025 worth ₹20,000 crores each.This will ease borrowing costs and create a positive investor sentiment.

 

2.      Variable Rate Repo (VRR) auction: On 7th February, 2025. The RBI aims to conduct a 56-day VRR auction of ₹50,000 crores. The 56-day period is selected to give banks greater lending flexibility. By conducting this VRR auction, the RBI aims to stabilize overnight money market rates and attain economic stability.

 

3.      Dollar-rupee swap auction: On January 31, the RBI will hold a $5 billion USD/INR buy/sell swap auction for a duration of 6 months. The cut-off will be determined based on the multi-pricing premium auction strategy. 

 

Impacts of this policy through the STEEP lens:

The three phased liquidity injection policy of ₹1.5 trillion (approximately $18 billion) by RBI reflects the pro-developmental and proactive stance of India. Through STEEP Analysis, we aim to underline the potential impacts across the entire economy.

 

1.  Social Impact:  

Increased liquidity could lower borrowing costs for businesses and households. Financial inclusion can gain momentum through increased channeling of funds to MSMEs. Due to increased EPFO enrollments by around 1.2 million, we can also expect the rapid job creation in the formal sector in the coming months. Increased liquidity may broaden urban-centric credit flow (currently, 65% of total). This would fuel the rural-urban divide; as well as the ‘middle class trap’.

 

2.  Technological Impact:  

Increased credit access may accelerate digital transformation and scale innovation. Sectors like fintech, e-commerce, and green energy have immense potential to harness. However, this can give rise to ‘zombie firms’ whose contribution is nil towards economic development. Such firms are able to cover only their interest payments but not their entire costs of debt financing. As of December 2024, there are 600 such firms in India, which is a concern.

 

3.  Economic Impact:  

In the short run, liquidity injection can stabilize bond markets,ease credit crunches and support government borrowing. However, if this liquidity is not absorbed productively, the credit intensive sectors may develop asset bubbles in the long run. Also, the rupee can depreciate yet further with imports becoming costlier due to cost push inflation.

Following the announcement of liquidity injection on January 28, 2025;

●       Nifty 50 rose 4% in the following week. 

●       Financial sectors (e.g., HDFC Bank, ICICI) are expecting higher benefits from lower borrowing costs.  

●       State's borrowing costs are expected to reduce by 20-30 bps.

●       The mid-cap stocks along with underperformed large-caps surged by 8% due to increased risk appetite.

●       Lastly, enhanced liquidity gives birth to speculative trading.Thus, India’s VIX Volatility Index spiked to 19.55 points following the announcement.

 

4.  Environmental Impact:  

If the increased liquidity is properly channelized towards developing the green infrastructure (renewable energy, EVs), India can be a step closer towards its Net Zero Carbon Emission Goals, 2030. Conversely, indiscriminate industrialization may undermine sustainability.  

 

5.  Political Impact:  

The government's aim to maintain a loose monetary policy is somewhat deviated from the RBI's inflation-tightened policies.  

The government in collaboration with the Monetary Policy Committee should also try to align this liquidity injection with our National Infrastructure Pipeline project. Furthermore,

Private-Public-Partnership (PPP) models may be used to promote inclusivity and increase our business competitiveness.

 

 

The Way Forward

Despite having an impressive growth rate of 8.2% last quarter, India suffers from import dependency, export fluctuations, insufficient FDI flows and an ever-depreciating currency. India's efforts for financial engineering is not new given that RBI introduced a similar Booster package of over ₹1.1 trillion in 2023 powered by MSF and SLF facilities. However, the potential pitfalls experienced that time can be avoided if we use our forex reserves judiciously, prioritise lending to MSMEs, agriculture and incentivize exports in the IT Sector.This will not only lead to improved logistics efficiency but also level up our existing supply chain. Lastly, liquidity injection is an important tool to foster economic stability and growth while keeping in mind the threshold inflation band of 2-6%.

 

 

 

Reference:

Rajan Raghuram, Acharya V. (2021-23), “Liquidity, liquidity everywhere, not a drop to use”

 

https://www.business-standard.com/article/finance/as-liquidity-tightens-rbi-injects-rs-1-trn-largest-inf usion-in-4-years-123031700981_1.html

 

https://m.economictimes.com/news/economy/finance/liquidity-push-rbi-readies-1-5-lakh-crore-injecti on/articleshow/117611950.cms

 

https://indianexpress.com/article/business/rbi-announces-5-bn-forex-swap-omos-and-vrr-to-inject-liqu idity-9802575/

 

https://pib.gov.in/PressReleasePage.aspx?PRID=1814774

 

Kalimpali M, et al. (2019) “Does Liquidity Infusion Impact Financial Stability? Evidence from Fed’s Corporate Bond Purchases” 

 

 

-By, Soham Sen and Nidhi Attri

M.Com, 1st Year.