Liquidity Trap

Published on 22 Nov 2025

• Recent economic trends in India indicate the presence of a liquidity trap despite the Reserve Bank of India (RBI) lowering interest rates by 100 basis points since February 2025.

• A liquidity trap occurs when, despite significant increases in the money supply and reductions in interest rates, there is little to no increase in borrowing or investment. 

• This situation arises because businesses and consumers are unwilling or unable to take on additional debt, even when borrowing costs are low.

• Theoretically, lowering interest rates should increase demand for funds.

• However, despite RBI cutting repo rate by 100 bps since Feb 2025, credit growth remains modest at 10% YoY.

• Causes are attributed to weak demand for credit, partial monetary transmission of rate cuts by banks, and global economic pressures like the US tariffs.

• Monetary policy in such a situation must be accompanied by parallel fiscal steps such as government expenditure or tax concessions in order to push the economy out of the trap and increase demand.

Keywords:

Liquidity Trap Reserve Bank of India RBI Monetary policy Expansionary Monetary Policy Repo rate