The Reserve Bank of India (RBI) has stepped in to alleviate the liquidity crunch in the country’s financial system, using dollar-rupee swaps to inject much-needed rupee liquidity.
This move, which is aimed at addressing the tightness in the financial system, comes as the Indian rupee faces mounting pressure, driven by a combination of corporate tax settlements and investor demand for the currency.
According to sources familiar with the matter, the central bank executed swaps worth around $3 billion on Friday. These swaps had varying maturities, including three, six, and twelve months, reflecting the RBI's strategic response to the situation.
However, the RBI did not immediately respond to requests for comment on the matter.
This action comes at a time when the Indian economy is grappling with a liquidity squeeze that has been further exacerbated by the demand for the local currency. Many businesses have rushed to settle their tax liabilities, while investors have borrowed significant amounts to buy stocks.
At the same time, the rupee is facing downward pressure from a surging US dollar. This combination of factors has led the Indian currency to lose more than 1% of its value against the dollar in the early months of 2025, undermining its performance from the previous year, when it was one of Asia’s best-performing currencies.
The central bank’s attempts to support the rupee, particularly through interventions in the currency market, have complicated its ability to maintain sufficient liquidity in the domestic financial system.
In recent weeks, India’s largest lenders have raised concerns over the tightening of liquidity, prompting informal requests to the RBI for additional measures.
Data from Bloomberg revealed that the Indian banking system was facing a deficit of nearly 2 trillion rupees ($23.1 billion) as of January 12, a concerning figure that added pressure on the central bank to take action.
Despite these concerns, the RBI's interventions to stabilise the rupee have had a direct impact on the liquidity available in the local banking system.
The central bank’s strategy of reducing its use of overseas forward contracts late last year, in favour of focusing on supporting the rupee domestically, has contributed to the ongoing liquidity challenges.
While this approach has managed to prevent a complete freefall of the rupee, it has simultaneously restricted the flow of rupees within the economy, making it more difficult for businesses and households to access the funds they require.
The consequences of the RBI's actions were reflected in the significant decline in implied yields on dollar-rupee onshore forwards, which track expectations of interest rates and currency liquidity.
On Friday, the three-month implied yield fell by 29 basis points, while the six-month premium dropped by 21 basis points, underscoring the shift in market expectations and the growing influence of liquidity conditions.
Looking ahead, the RBI’s efforts to ease liquidity may continue, with some analysts suggesting that the central bank could become a net buyer of government bonds during the upcoming financial year, starting April 1.
This move would help inject more liquidity into the local market, potentially easing some of the strain on the banking system. The RBI's focus on stabilising the rupee while also addressing liquidity issues highlights the delicate balancing act the central bank faces in managing the country’s financial stability.
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