RBI Steps Up Liquidity Management Through Forex Market
The Reserve Bank of India has intensified efforts to remove excess cash from India’s banking system, with its foreign-exchange operations estimated to have absorbed nearly $20 billion worth of surplus rupee liquidity.
According to Reuters, citing two bankers, the central bank has recently used a combination of dollar-rupee sell-buy swaps, spot dollar sales, government bond sales and variable-rate reverse repo operations to manage the unusually large amount of liquidity in the financial system.
The move comes after banking-system liquidity reached exceptionally high levels earlier in September.
Banking Liquidity Surplus More Than Halved
The scale of the adjustment is significant. Banking-system surplus liquidity had reached a record ₹11.16 trillion during the first week of September. Reuters reported that subsequent RBI measures, together with tax-related outflows, have reduced that surplus by more than half.
A measure known as core liquidity, which attempts to remove short-term fluctuations in banks' daily cash balances, has also declined.
Gaura Sengupta, chief economist at IDFC First Bank, estimated that core liquidity fell from about ₹14.2 trillion on September 4 to ₹11.5 trillion. Her estimates attributed much of the decline to RBI dollar sales through spot transactions and sell-buy swaps, alongside bond sales.
How Do RBI’s Dollar-Rupee Swaps Remove Cash?
The mechanics are important because foreign-exchange intervention can affect both the currency market and banking liquidity.
In a sell-buy dollar-rupee swap, the RBI sells dollars to banks in exchange for rupees while agreeing to reverse the transaction at a future date. The immediate leg therefore takes rupees out of the banking system.
Recent reporting indicates that the RBI has increasingly used such transactions alongside its more traditional liquidity-management tools. Business Standard reported last week that the central bank had conducted at least $10 billion of sell-buy swaps over the preceding weeks, with maturities ranging from around one month to six months.
The nearly $20 billion estimate reported subsequently represents the estimated net liquidity impact of FX operations, rather than necessarily the gross size of all foreign-exchange transactions conducted by the central bank.
RBI Is Also Selling Government Bonds
Foreign-exchange operations are only one part of the RBI's broader liquidity strategy.
On September 28, Reuters reported that the central bank had completed ₹1 trillion in net government-bond sales during the current financial year, its largest such net sale in more than a decade. Selling government securities absorbs rupees from buyers and therefore withdraws liquidity from the financial system.
Earlier in September, the RBI had announced a ₹1 trillion open-market bond-sale programme as it sought stronger tools to deal with the cash surplus.
Why Is the RBI Removing Excess Liquidity?
A large and persistent liquidity surplus can push short-term money-market rates below the central bank's intended policy settings.
Removing part of that surplus allows the RBI to exert greater control over monetary conditions without necessarily relying on a broad measure such as increasing the Cash Reserve Ratio (CRR).
RBI Governor Sanjay Malhotra had previously indicated that the central bank had several instruments available for absorbing surplus liquidity, including foreign-exchange swaps and bond sales.
This makes the current operations significant: the RBI is using targeted market instruments to manage liquidity while simultaneously navigating pressures in the foreign-exchange market.
Rupee Management Adds Another Dimension
The RBI's intervention is taking place while the rupee has been under pressure from factors including elevated crude-oil prices, US Treasury yields and portfolio flows.
On September 29, the rupee closed at 95.98 per US dollar after touching a two-month low of 96.1475 during the session. Dollar sales by state-run banks, which traders believed were likely conducted on behalf of the RBI, helped limit the currency's decline.
By September 30, conditions had improved somewhat as oil prices eased and expectations of another US Federal Reserve rate increase declined.
This illustrates why FX operations can serve more than one purpose: dollar sales can moderate sharp currency movements while simultaneously withdrawing rupees from the domestic banking system.
There Is a Trade-Off: Hedging Costs Are Rising
Liquidity absorption through the FX market is not without consequences.
The RBI's sell-buy swaps have pushed dollar-rupee forward premiums higher. Reuters reported that the one-year premium had risen by around 50 basis points during September, increasing the cost of hedging dollar exposure for some companies and investors.
That creates a balancing challenge for the central bank. Reducing excessive domestic liquidity and limiting currency volatility may support monetary control, but sustained intervention can also influence funding conditions and foreign-exchange hedging costs.
What Happens Next?
The RBI's actions suggest that liquidity management is likely to remain an important part of monetary operations while surplus cash remains elevated.
Sengupta estimated that another ₹1.5 trillion of liquidity could potentially be withdrawn through bond sales and sell-buy FX swaps. That is an economist's estimate rather than an announced RBI target.
The pace of further intervention will depend on developments including banking-system liquidity, government cash flows, currency-market conditions and the RBI's assessment of monetary conditions.
For banks and financial markets, the key question is therefore not simply how much liquidity the RBI has already removed, but how far it intends to continue normalising the unusually large surplus.
