RBI’s liquidity movements are explained: the Hindu business line

The Bank of the Reserve of India has made several auctions for the purchase/sale of dollars and market operations open since January 2025. These measures help the RBI to administer volatility in the currency market and instill liquidity in the banking system. These political actions complement the reduction of the interest rate announced by the governor of RBI in early February. A reduction in the interest rate reduces the cost of loans and encourages national companies and homes to spend more. However, if the liquidity in the banking system is inadequate, a reduction of rates may not be effective since the capacity of the banks to lend money will be limited.

To help banks in this scenario, the Central Bank generally buys governmental values ​​of banks in exchange for national currency, which increases liquidity in the system. The purchase (or sale) of the central bank of the government bonds to influence the liquidity in the banking system is called the open market operation (OMO). In an OMO, when the RBI buys government values ​​to instill liquidity, the secondary yields of the market of the governance securities are also affected.

Exchange auctions

Together with the conventional omos, the RBI has also made several auctions for the purchase/sale of dollars. An exchange of purchase/sale from a central bank is an instrument in which the Central Bank buys foreign currency from a commercial bank in exchange for national currencies, with the commitment to reverse the transaction to a predetermined fee and date. For example, internal liquidity in the banking system increases when the RBI buys US dollars from commercial banks against rupees.

In addition, since the RBI is buying dollars, these purchases add dollars temporarily to the holdings of the RBI Forex Reserve. In an exchange of currencies, the RBI also undertakes to reverse the transaction on a future date, selling dollars against rupees to the commercial bank at a predetermined price. The default price entails a cousin, which is determined through an auction made by the RBI.

The justification for performing these Forex swaps is double. The first objective is the infusion of internal liquidity, since the purchase of dollars by the central bank of commercial banks can address the problem of liquidity shortage in the banking system. However, one must remember that with an exchange transaction, the impact of liquidity infusion is invested on the liquidation date.

The second and possibly the most important objective of Forex swaps is the management of exchange rates.

Dollar-Rupee purchase/sale swaps add dollars to the RBI Forex Reserve and improve the capacity of the Central Bank to intervene in the Forex market.

The series of currency exchange auctions announced by the RBI is possibly required by strong depreciation of the rupee in recent months.

Due to several economic and geopolitical reasons, most emerging markets, including India, are experiencing a massive foreign portfolio capital. For example, since September 2024, India is experiencing large net outputs FII. It has exerted pressure on the exchange rate, and the rupee was sharply depreciated of 83.5/dollar on September 22, 2024, to cross 87.5/dollar on February 7, 2025 (graph). Although the rupee is officially a floating exchange rate, and the RBI explicitly refrains from specific levels or exchange bands, the RBI intervenes in the currency market to manage excessive volatility and guarantee ordered market conditions.

Given the acute and continuous depreciation of the rupee, the RBI had to sell dollars and buy rupees in the spot market. By increasing dollar supply in the spot market, the RBI tried to reduce depreciation pressure on rupee.

But, since the RBI is buying rupees per dollar, this transaction also configures the liquidity of the internal market rupee. To relieve this liquidity voltage in the domestic market, the RBI participates in the Forex exchange segment, effectively changing the spot market pressure to a longer maturity, which could vary from a month, two months, three months, six months, one year or even three years.

It is remarkable that RBI began with an exchange of six months in January 2025 and then changed to longer maturity swaps in the posterior auctions.

Common objective

Therefore, the swap omo and forex announced by the RBI meet a common goal, which is to ensure that any liquidity shortage does not limit the national banking system. In addition, the RBI also used the exchange of currencies to relieve pressure on the rupe by reducing the front premium. The change to a longer liquidation period by the RBI may indicate that the RBI expects the uncertainty in the currency market to continue for a while.

These two policies have tried to create a pro-process policy environment in infusing lasting liquidity in the banking system and reducing volatility in the currency market. These measures aim to reverse the recent deceleration in the real growth of Indian GDP. It remains to be seen how these policies lead to the real -credit counterweight in India.

RBI measures have also led to a decrease in short -term bond yields. However, yields of 10 years or more bond have not been affected. It is possible that the RBI needs to take some measures to reduce the performance of long -term bonds.

Geopolitical developments are also helping RBI. In recent days, the dollar has weakened a bit, and has helped stabilize the rupee.

RBI’s policy measures and the lowest uncertainty about government policies in the United States have also led to a strong decrease in the front premium of one year of dollar/rupe. It can help foreign currency loans by Indian companies in addition to stabilizing the exchange rate.

However, Fii’s net outings continue. Significant tensions and policy uncertainties remain in the international and geopolitical economy. In such volatile times, any global interruption can trigger a collective panic among foreign investors.

The RBI needs to step carefully to contain inflation pressures while safeguarding growth, particularly when the government has reoriented policy priorities by stimulating internal consumption through tax cuts.

PAL is with Iim Calcutta, and Sanati is an associate professor at the National Institute of Banking Management, Pune