Short-term interest rates at India's central bank remained unchanged, but it urged lenders to hold a larger share of their deposits in cash - a step aimed at soaking up excess liquidity in the banking system.
The Reserve Bank of India increased the cash reserve ratio - the proportion of deposits that commercial banks must hold in cash - from 7 percent to 7.5 percent, starting Nov. 10.
The decision came as part of a half-yearly review of monetary policy by the Reserve Bank of India. The review left key interest rates unchanged.
"The domestic conditions are as expected, both in terms of growth and stability, supply and demand," said RBI Governor Y. Venugopal Reddy. "Therefore, the status quo of monetary policy can continue, except for one, and that is liquidity."
The Indian financial system is flush with funds because a surge in foreign capital into the country.
Foreign investors have bought more than US$22 billion (15.27 billion EUR) in Indian stocks to date this year, nearly three times what they invested last year.
That money has come on top of billions of dollars (euros) in investments by private equity funds and global companies eager to seize opportunities in one the world's fastest-growing economies.
Such inflows have added to liquidity to India's banking system, and threaten to fuel inflation.
"The most important thing has been the huge liquidity, and this liquidity has been induced by large capital inflows relative to our local absorption capacity," Reddy said. "Since absorption capacity doesn't increase quickly, we have to do something about the whole situation."
The hike in cash reserve ratio, or CRR, would drain 160 billion rupees (US$4 billion; 3.3 billion EUR) from the banking system, he said.
This is the fourth time the central bank has increased the CRR this year.
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