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India’s liquidity surplus has now reached about ₹11.6 lakh crore, roughly 3% of GDP. Barely a fortnight ago, it was only around ₹2–3 lakh crore. The speed of the increase is as striking as its size. I do not know of another normal period when India has carried a liquidity surplus of this magnitude. We reached roughly 4% of GDP during Covid, but that comparison is misleading because GDP had collapsed and the RBI had deliberately flooded the system with liquidity. The danger is to misdiagnose this as a temporary liquidity problem. A reverse repo allows banks to park surplus cash with the RBI for a specified period in return for interest. It works well when the surplus has a predictable reversal, for example when a large government payment temporarily injects cash that subsequent tax payments will drain. That is not the situation today. The surplus is the consequence of a large and deliberate liquidity injection. Misdiagnosing a FII led foreign-currency outflow as a run helped create this problem in the first place. Misdiagnosing the resulting liquidity as temporary could compound it. Banks are already sending a clear signal. They have shown little appetite even for short-duration absorption and the 30-day operation was heavily undersubscribed. This happens from time to time. What is different now is the quantity of liquidity and why it is there. Banks are effectively saying that 5.24% is not sufficient compensation for locking up this amount of money for longer. That is a price signal, not a credibility problem. Some suggest that banks should simply lend the money. That is not a serious solution at this scale. I have spent the last five years screening 30-40 infrastructure loan proposals above ₹5,000 crore a month. There simply is not enough bankable demand to absorb ₹30–40 lakh crore of additional lending quickly. The total outstanding book of all specialist infrastructure lenders put together is less than 25 lakh crore forget about annual lending. Banks are not competent to make long term infra loans. Infrastructure loans are sanctioned and disbursed over years. A borrower cannot build a nuclear power plant in six months simply because the banking system has excess cash. The dangerous way to make banks lend is the 2008 model: encourage aggressive lending and reassure banks, explicitly or implicitly, that they need not worry too much about eventual defaults. The central bank will look the other way even when they are not recognizing losses (forbearance). We know where that ends. Today's liquidity problem then becomes tomorrow's bad-loan problem. The cleaner solution is durable sterilisation. My preference remains the Market Stabilisation Scheme. Issue securities, absorb the liquidity and keep the proceeds impounded. Yes, this has an interest cost. That is the cost of sterilising liquidity created by the policy intervention. If MSS is not used, the RBI needs another durable instrument that compensates banks sufficiently to participate voluntarily. That will probably require paying a higher interest rate. I see no costless solution. Use of force through CRR is a bad option. Banks earn nothing on CRR. Like RBI tried punishing currency speculators , they may think of punishing banks for “hoarding” liquidity. We have to recognize that banks are acting in the best interests of their depositors and shareholders. This is what they are supposed to do. The RBI has used force before. In 2023 it imposed an incremental CRR when banks were unwilling to absorb enough liquidity voluntarily. The I-CRR temporarily impounded part of the increase in deposits. That was easier to justify because the liquidity was viewed as temporary and was subsequently released. The situation today is different. A CRR increase would also impose costs on banks irrespective of whether they contributed to the present surplus. I hope the RBI offers a durable instrument at a price banks are willing to accept rather than forcing the adjustment through reserve requirements. If handled well, this could be a minor problem that everyone forgets in six months. If handled badly, it can linger, become embedded in bank balance sheets and create much larger problems later. Taxpayers are ultimately left with two bad choices: pick up a smaller and visible bill now, or risk paying through the nose later through inflation, higher interest rates, financial stress and taxes. I would choose the smaller bill now.

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