The Reserve Bank of India’s (RBI) operations to mop up a massive liquidity surplus have inadvertently thrust into the spotlight a basic drawback in the inflation targeting regime we adopted in 2016: the disconnect between the rate-setting role of the six-member Monetary Policy Committee (MPC) and its helplessness when it comes to managing liquidity, the flip side of interest rate determination.
Now, RBI is responsible for liquidity levels in the banking system, which must align with what the economy needs to keep its wheels churning. This entails engaging in open market operations (OMOs), mainly buying and selling bonds to infuse and withdraw liquidity respectively, as macro conditions demand.
Also, as the lender of last resort, RBI is expected to fix inter-bank liquidity mismatches that cannot be met by the overnight call money market. Yet, trouble arises when RBI’s moves, especially attempts to induce durable rather than temporary liquidity, result in undoing or offsetting the effect of the MPC’s rate decisions.
Recall that under the inflation targeting regime, the responsibility of setting the policy rate of interest—the one at which RBI infuses liquidity—rests squarely with the MPC. But this panel has no say in either the mechanics of how that is achieved or RBI’s liquidity operations.
One can argue that the nitty-gritty of how the policy rate is put into effect is an operational matter best left to experts at the central bank. But the same argument cannot be extended to liquidity measures, which have a direct bearing on interest rates in the economy.
Today’s surplus money might be an unintended consequence of large foreign-currency inflows under RBI’s concessional forex swap scheme—pegged at over $136.4 billion—and the resultant increase (estimated at a bit over ₹11 trillion) in system liquidity. But this is not the first time liquidity levels have gone out of kilter with the MPC’s rate calls. Nor has this always been unintended.
There have been occasions in the past when RBI’s liquidity operations have been at odds with the MPC’s position on the repo rate.
In its monetary policy announcement of 5 December 2025, for instance, RBI announced OMOs to purchase government securities (G-Secs) of ₹1 trillion and 3-year dollar/rupee buy-sell swaps of $5 billion, only to double the amount less than three weeks later. This, despite its admission that system liquidity was at an average surplus of ₹1.5 trillion in the period since the MPC had last met (October 2025). RBI did not explain its decision.
But it did serve to groom the G-Sec market, perceptibly, which assumes relevance in the context of a structural conflict between RBI’s role as our monetary authority and as the government’s debt manager. The latter enjoins it to help the government borrow at the lowest possible rate.
So the system can be flush with liquidity, as in recent months, even if it acts at cross purposes with the MPC’s stand. No wonder both the 2009 Raghuram Rajan Committee on Financial Sector Reforms and 2013 report of the Financial Sector Legislative Reforms Commission recommended moving the government’s debt management away from RBI to an independent public debt agency.
Unfortunately, the idea has remained on paper so far. However, growing instances of RBI’s liquidity management being out of whack with its rate-setting panel’s decisions suggest it might be time to review the MPC’s remit at the very least.