FCNR inflows push short-term borrowing costs lower amid rising liquidity: ICICI Bank

New Delhi: Interest rates on three-month certificates of deposit (CDs) have fallen by more than 100 basis points from their peak this year as a surge in FCNR (B) inflows has pushed liquidity higher in the banking system, according to ICICI Bank Research.The report said the impact of the foreign currency inflows is being felt more strongly in short-term money market rates, which have moved well below the policy repo rate. Rates on six-month and one-year CDs have also declined by around 100 basis points and 90 basis points, respectively, from their peaks earlier this year. The sharp decline in short-term borrowing costs comes after gross FCNR (B) inflows reached around USD 127 billion, significantly changing the liquidity outlook for the rest of the financial year, ICICI Bank said.Before the FCNR (B) scheme, average system liquidity stood at around INR 1.6 lakh crore, or 0.6 per cent of net demand and time liabilities (NDTL), in May 2026. This rose to INR 3.7 lakh crore, or 1.3 per cent of NDTL, in August, while current liquidity has reached around INR 10.5 lakh crore, or 3.9 per cent of NDTL.The bank expects liquidity to remain elevated in the coming months, with the banking system surplus likely to be around 2.5 per cent of NDTL by March, even after accounting for seasonal demand for currency and reserve balances.The report said the rise in liquidity could have implications beyond short-term borrowing costs, as historical data show a relationship between liquidity and inflation with a lag. The correlation between system liquidity and core consumer price inflation is 0.50 with a 12-month lag, while it rises to 0.62 for core inflation excluding precious metals.“Today’s liquidity has an impact on ‘future’ inflation,” ICICI Bank Research said, warning that the current increase in liquidity could push future inflation higher than its present trajectory.The bank expects headline inflation at 4.5 per cent in FY28, while core inflation excluding precious metals is estimated to settle at around 4 per cent.Against this backdrop, ICICI Bank said some level of permanent liquidity absorption may be required, along with temporary measures. It said long-term variable rate reverse repo operations (VRRR) could provide flexibility to absorb excess liquidity while allowing funds to be released later when required. On monetary policy, ICICI Bank expects a shallow rate-hike cycle ahead, with a 50 basis point increase in the policy rate likely to bring real rates towards the lower end of the neutral range. If inflation turns out higher than its current trajectory, the bank said a 75 basis point hike would be sufficient to bring real rates in line with the neutral rate band.