The Reserve Bank of India might drain up to $22 billion in excess liquidity from the financial system. The reason behind this move is rolling foreign investments that forces the central bank to absorb the dollar inflows. This also encourage to sell rupees to cap gains in the local currency.
In year 2017, the foreign investments into debt and shares are of approximately $31 billion. Last year, the foreign investments into debt and shares was just $2.7 billion. This was due to factors like low inflation and improving economic growth of India.
At present, the strong inflows have sent the rupee up by 7 percent against the dollar. Thus RBI is said to be forced to buy more than $10 billion in spot market in year 2017. RBI will also buy $10 billion in forwards.
In financial system, you can observe that the rupee sales have added liquidity. However, ban on higher-denomination currency in November has sparked a surge in bank deposits.
The average daily liquidity has increased up to 3 trillion rupees, which is more than the goal of RBI. RBI goal was around 1 trillion rupees, according to traders.
This scenario will surely push the RBI to step up debt sales to eliminate liquidity and to avoid any inflationary impact.