RBI’s Liquidity Moves and Forex Market Intervention

Context: The Reserve Bank of India has conducted several dollar-rupee buy/sell swap auctions and open market operations since January 2025 to manage volatility in the forex market, and infuse liquidity into the banking system. These measures supplement the interest rate cut announced by the RBI Governor in February 2025 to boost economic activity. 

Reasons behind RBI Intervention

• The Indian rupee follows a managed floating exchange rate regime. This means that the central bank (RBI) intervenes in the foreign exchange market to buy or sell dollars in order to stabilise the value of the rupee. 
• Due to several economic and geopolitical reasons, most emerging markets (including India), are experiencing a massive outflow of foreign portfolio capital.
  • E.g., Foreign investors have withdrawn approximately $29 billion from Indian equities in the period between October 2024 to March 2025, marking the largest outflow in any six-month period.
• This has put pressure on the exchange rate, and the rupee sharply depreciated from 83.5/dollar on September 22, 2024, to cross 87.5/dollar on February 7, 2025. 

Steps Taken by RBI:  

1. Interest Rate Cut:

• In February 2025, RBI reduced the Repo rate by 25 basis points to 6.25% (first cut in nearly 5 years). 
• An interest rate cut reduces the cost of borrowing and encourages domestic firms and households to spend more. 
• However, if liquidity in the banking system is inadequate, a rate cut may not be effective as banks’ ability to lend money will be limited. In such a scenario RBI can conduct open market operations. 

2. Open Market Operations (OMOs):

• In March 2025, RBI announced to conduct OMO purchases of government securities worth ₹1 lakh crore in two tranches of Rs 50,000 crore each.
• The central bank’s buying (or selling) of government bonds to influence liquidity in the banking system is called an open market operation (OMO).
  • Bond Purchase → Increases liquidity (more money in the banking system). 
  • Bond Sale → Reduces liquidity (less money in circulation). 
• Presently, RBI is buying government securities from the banks in exchange for domestic currency, thereby increasing liquidity in the banking system. 
• Impact of OMOs:
  • Short-term bond yields have fallen, making borrowing cheaper. 
  • However, long-term bond yields remain high, meaning long-term investments are still costly. 
  • The RBI may need to target long-term bond yields through further measures. 

3. Dollar-Rupee Buy/Sell Swap Auction:

• RBI has announced to conduct a USD/INR Buy/Sell Swap auction for ₹10 billion with a tenor of 36 months in March 2025. Earlier, RBI conducted a $5.1-billion swap in January 2025 for a six-month tenure. 
• A buy / sell forex swap by a central bank is an instrument where the central bank buys foreign currency from a commercial bank in exchange for domestic currencies, with a commitment to reverse the transaction at a predetermined future rate and date.

• Objectives of Forex Swaps:
  • Liquidity Infusion – When RBI buys dollars, it injects rupees into the banking system, helping banks lend more. 
  • Exchange Rate Stability – The dollar-rupee buy/sell swaps add dollars to the RBI’s forex reserve and improve the ability of the central bank to intervene in the forex market. 

OMO and the forex swap have tried to create a pro-growth policy environment by infusing durable liquidity in the banking system and reducing volatility in the forex market. These measures are aimed at reversing the recent slowdown in India’s real GDP growth. 

Way Forward

• Continued Forex Market Intervention: The RBI should continue to use forex swaps tactically while keeping a watch on their effect on forward premia and exchange rate stability. E.g., Recent geopolitical events have resulted in a temporary softening of the US dollar against major currencies, bringing some relief to emerging markets such as India.
• Focus on Long-Term Bond Yields: To make the environment more favourable for long-term investments, the RBI may consider calibrated steps like buying longer-term government papers via OMOs. E.g., Analogous interventions had worked well in earlier phases of economic slowdown (post-COVID recovery).
• Monitoring Inflation Pressures: The RBI needs to tread carefully to contain inflation pressures while safeguarding growth, particularly when the government has re-oriented policy priorities by stimulating domestic consumption through tax cuts.