Liquidity in the banking system in India has slipped into its deepest deficit in almost six months, inflating borrowing costs, as outflows due to corporate advance taxes and the Reserve Bank of India’s likely actions to stabilise the rupee have drained lenders of funds.

As of September 16, the RBI infused ₹68,785.94 crore into the banking system, the most since March 24, central bank data showed. An injection of funds by the RBI into the banking system indicates tight liquidity conditions.

Advance tax collections in the first half of this fiscal year have increased 20% on-year to ₹3.54 trillion. Liquidity is expected to return to the system in about 10 days.

Although advance tax outflows and GST are normal factors where the flows will come back into the system, the bigger concern from a structural liquidity perspective is the currency sale by the RBI. The rupee weakened against the US dollar due to higher crude oil prices, reaching a record closing low of 83.27 per dollar.

The RBI is said to have been intervening in the currency market through dollar sales to curb excessive volatility in the exchange rate. This has caused a drain of rupee liquidity from the banking system. However, the liquidity situation is expected to improve by the end of the week as funds frozen in the Incremental Cash Reserve Ratio would flow back into the system. The RBI would continue to actively manage liquidity due to exchange rate pressure and central bank meets.

The RBI earlier announced the Incremental Cash Reserve Ratio for banks to reduce excess liquidity in the banking system and contain inflation risks. The central bank has now decided to discontinue the ICRR and release the funds impounded in phases. The tighter liquidity conditions have pushed up the weighted average call rate (WACR), which is higher than the Marginal Standing Facility (MSF). The repo rate is currently at 6.50%.