The Reserve Bank of India (RBI) increased the amount of liquidity it planned to inject into the banking system through an overnight infusion on Wednesday, following heavy intervention in the foreign exchange market over the past two sessions.

The central bank offered 2.50 trillion Rupees ($28.85 billion) through an overnight variable rate repo auction, its largest single-day infusion in more than a year. Banks subscribed to 1.94 trillion Rupees.

The RBI's frequent intervention in the foreign exchange market has tightened Rupee liquidity, potentially undermining the impact of last week's rate cut, as banks may struggle to pass on lower rates to customers.

Market participants widely believe that surplus liquidity is essential for the effective transmission of lower rates, Reuters reports.

India's banking system liquidity deficit surged fourfold in less than a week, reaching approximately 2 trillion Rupees as of Tuesday. Traders pointed to tax outflows and the RBI's aggressive Dollar sales as key factors behind the sharp increase.

On Monday, the RBI sold between $4 billion and $7 billion to intervene in the foreign exchange market and support the Rupee. It continued Dollar sales on Tuesday to stabilise the currency, which has been under pressure due to portfolio outflows and uncertainty over US trade tariffs.

The boost in the infusion amount comes just a day after the central bank increased the proportion of government securities it plans to buy, doubling it to 400 billion Rupees on Thursday. Over the past month, the RBI has injected more than 1.5 trillion Rupees into the system.

"Since the RBI promised liquidity infusion, which will also support rate cut transmission, any aggressive FX sale will curtail that intention. I believe the RBI will want to sterilise any large FX interventions that drain out domestic liquidity sizeably, to keep the latter around neutral in line with the monetary policy stance," said ANZ Research economist Dhiraj Nim.