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The recent rise in India's banking system liquidity surplus due to government spending and capital inflows may not be sustainable as demand for cash picks up towards the end of the fiscal year, economists said.

India's banking system liquidity surplus has averaged above 1.50 trillion rupees ($18.11 billion) on a daily basis from Dec. 1 to Dec. 14, as against an average of around 500 billion rupees in November, and less than 100 billion rupees in October.

"Liquidity has improved on account of chunky month end spending by the government," said Vivek Kumar, an economist at QuantEco Research.

"We believe the surplus in banking system liquidity would moderate as cash demand could accelerate seasonally resulting in an incremental outflow of at least 1 trillion rupees before the end of FY23," Kumar added.

IDFC First Bank expects the liquidity to be in "mild deficit" by March.

The private bank expects balance of payments deficit of $61 billion and currency leakage of 2.3 trillion rupees for this financial year, said Gaura Sen Gupta, India economist at IDFC First Bank.

The deficit could be balanced by a likely increase in spending by states as well as the central government, Sen Gupta added.

Earlier this month, the Reserve Bank of India Governor Shaktikanta Das attributed the improved liquidity conditions to the pickup in government expenditure and higher foreign inflows.

Some market participants pointed to RBI’s dollar purchase that infused cash into the system.

The Indian rupee had appreciated to 80.51 against the dollar in November, posting its first monthly gain this year.

"Banking system liquidity surplus has also increased on RBI's purchase of dollars amidst recent appreciation pressure on rupee," QuantEco Research's Kumar said.

Foreign investors poured over $4 billion into India's equities markets in November, while government bonds, too, whet their appetite.

"Unless we see meaningful improvement in flows, liquidity situation will worsen. Only government spending may not be able to keep liquidity in surplus," said Soumyajit Niyogi, director for core analytical group at India Ratings & Research.

($1 = 82.8200 Indian rupees)