RBI Conducts Dollar-Rupee Swap to Inject Liquidity

The Reserve Bank of India (RBI) has recently executed a dollar-rupee buy/sell swap worth $5 billion. This transaction aims to inject liquidity into the financial system. The swap will be reversed on August 4, 2025. The RBI received an overwhelming response, with bids amounting to $25.6 billion, which is five times the notified amount. This indicates strong demand for dollars in the market.

About Dollar-Rupee Swaps

• A dollar-rupee swap is a financial transaction where the RBI buys US dollars from financial institutions and sells Indian rupees in return.
• This operation increases liquidity in the financial system.
• The second leg of the swap will occur in August when the RBI will sell back the $5 billion at a forward rate.
• This mechanism ensures that the RBI can manage currency fluctuations and liquidity effectively.

Current Liquidity Situation

• The liquidity situation in India has been challenging.
• Since mid-December, the market has faced a persistent deficit.
• As of January 30, the liquidity deficit stood at Rs 2.22 lakh crore.
• The daily average liquidity gap in January was Rs 2.04 lakh crore.
• The RBI’s recent open market operations (OMO) aimed to ease this liquidity crunch.
• In the week ending January 24, the RBI purchased Rs 20,000 crore, doubling its previous week’s purchases.

Government Spending and Market Expectations

Market participants anticipate improved liquidity by August. This expectation is linked to increased government spending following the budget announcement on February 1. As government expenditures rise, it is expected to stimulate economic activity and enhance liquidity in the market.

Challenges in the Green Bond Auction

In a separate auction for green bonds, primary dealers faced challenges. They were required to purchase Rs 3,945.5 crore worth of green bonds, while the total notified amount was Rs 5,000 crore. The reluctance to buy was attributed to the lack of mandates for such investments. The RBI received bids worth Rs 7,718.8 crore but accepted only Rs 1,053.8 crore due to pricing concerns.

Impact on the Rupee

The Indian rupee closed at 86.6 per dollar, slightly down from the previous close of 86.62. Factors affecting the rupee include portfolio outflows, expectations of interest rate cuts, and uncertainties regarding US trade policies. These elements contribute to the volatility of the rupee in the global market.

Questions for UPSC:

1. Critically analyse the impact of liquidity management on the Indian economy.
2. What are the implications of dollar-rupee swaps for currency stability? Comment.
3. Explain the role of the Reserve Bank of India in managing financial liquidity.
4. What are green bonds? How do they contribute to sustainable finance in India?

Answer Hints:

1. Critically analyse the impact of liquidity management on the Indian economy.

1. Liquidity management affects interest rates, influencing borrowing costs for businesses and consumers.
2. Effective liquidity management can stimulate economic growth by ensuring sufficient funds for investments.
3. Persistent liquidity deficits can lead to economic slowdowns, impacting GDP growth and employment rates.
4. RBI’s interventions, like dollar-rupee swaps and OMOs, aim to stabilize liquidity and support economic stability.
5. Market confidence is boosted when liquidity is managed well, attracting foreign investments and encouraging economic resilience.

2. What are the implications of dollar-rupee swaps for currency stability? Comment.

1. Dollar-rupee swaps help stabilize the exchange rate by providing liquidity in foreign currency, reducing volatility.
2. They allow the RBI to manage the supply of dollars and rupees, thus influencing inflation and trade balances.
3. Swaps can mitigate panic in currency markets by ensuring adequate dollar availability during crises.
4. They reflect the RBI’s proactive approach to currency management, enhancing investor confidence in the Indian economy.
5. However, excessive reliance on swaps may lead to vulnerabilities if not complemented by sound fiscal policies.

3. Explain the role of the Reserve Bank of India in managing financial liquidity.

1. The RBI acts as the central bank, regulating the money supply and interest rates to maintain economic stability.
2. It conducts open market operations (OMOs) and liquidity adjustment facilities to manage short-term liquidity needs.
3. The RBI uses tools like dollar-rupee swaps to inject liquidity and stabilize currency value.
4. It monitors financial markets and intervenes when necessary to prevent liquidity crises and ensure smooth functioning.
5. The RBI also provides guidance on credit availability, influencing lending practices among commercial banks.

4. What are green bonds? How do they contribute to sustainable finance in India?

1. Green bonds are fixed-income financial instruments specifically earmarked for funding environmentally sustainable projects.
2. They help raise capital for renewable energy, energy efficiency, and other green initiatives, promoting sustainable development.
3. Green bonds enhance access to finance for projects that mitigate climate change, supporting India’s commitments under the Paris Agreement.
4. They attract a growing pool of investors focused on environmental, social, and governance (ESG) criteria.
5. The issuance of green bonds reflects India’s transition towards a more sustainable economy, contributing to long-term economic resilience.