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RBI’s Dollar-Rupee Swap
Context:
After executing a $5 billion dollar-rupee swap less than a month ago, the Reserve Bank of India (RBI) has now decided to inject additional rupee liquidity through another $10 billion dollar-rupee buy-sell swap arrangement.
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- Announced on February 21, this initiative aims to provide a sustainable solution to the system’s liquidity constraints while simultaneously stabilising the rupee and bolstering the country’s foreign exchange reserves.
Rationale Behind the Swap
- Stabilising Currency: The swap mechanism serves as a tool to stabilise the currency by offering immediate liquidity support.
- Minimising Volatility: This move can ease pressure on the rupee during foreign fund outflows, reinforcing market confidence and minimising excessive exchange rate volatility.
- Strengthening Forex Reserves: Additionally, the initiative will strengthen the RBI’s dollar reserves, particularly as the central bank continues its interventions in the forex market to prevent further depreciation of the rupee.
Severity of the Liquidity Crunch
- The Indian banking system witnessed its worst liquidity crisis in over a decade in January 2025.
- The liquidity deficit peaked at Rs 3.15 lakh crore on January 23, marking its lowest level in nearly 15 years.
- This situation was exacerbated by tax outflows, GST payments, and the RBI’s forex market interventions to stabilise the rupee, as well as outflows due to currency in circulation (CIC).
- The deficit forced banks to rely heavily on market borrowing, driving interbank call money rates above the policy repo rate of 6.50 percent, as reported by Crisil.
- As part of its rupee stabilisation efforts, the RBI has been selling dollars, thereby extracting an equivalent rupee amount from the financial system.
- As of December 31, 2024, the RBI’s outstanding net forward dollar sales reached $67.93 billion.
- Meanwhile, its spot market dollar sales totaled $45 billion in the third quarter, with $15.15 billion in December, $20.22 billion in November, and $9.27 billion in October.
How the Swap Works
- The dollar-rupee swap follows a simple buy-sell foreign exchange structure.
- Banks sell US dollars to the RBI while simultaneously agreeing to repurchase the same amount at the end of the swap period.
- In the first leg of the transaction, banks sell dollars to the RBI at the FBIL Reference Rate on the auction date.
- Settlement takes place on a spot basis, with the RBI crediting rupee funds to the successful bidder’s current account while the bidder transfers dollars into the RBI’s nostro account.
- In the reverse leg of the transaction, rupee funds, along with the swap premium, must be returned to the RBI to retrieve the dollars.
RBI’s Efforts to Address Liquidity Shortages
- Over the past five weeks, the RBI has injected more than Rs 3.6 lakh crore of durable liquidity into the banking system through various measures, including debt purchases, forex swaps, and longer-duration repos.
- Throughout January, the central bank introduced multiple initiatives to ease liquidity constraints, such as variable rate repo (VRR) auctions of varying tenors and a series of daily VRR auctions between January 16 and January 23.
- Additionally, the RBI conducted a $5 billion dollar-rupee swap on January 31 and open market operations (OMO) purchase auctions of government securities worth Rs 60,000 crore.
- A 56-day VRR auction scheduled for February further demonstrates the RBI’s commitment to addressing liquidity shortages and ensuring financial stability.
