RBI Injects USD 10 Billion To Ease Liquidity Shortage: Report

The Reserve Bank of India (RBI) auctioned a three-year dollar-rupee buy-sell swap on Friday, injecting USD 10 billion into the banking system in an attempt to curb the current liquidity deficit. According to a Bloomberg report, the auction was well-subscribed, with bids 1.6 times the notified size. This follows a USD 5 billion six-month swap in January, as the central bank increases efforts to support the financial system.

Bridging Shortage of Liquidity

India's financial system has been faced with a severe liquidity shortage since the fourth quarter of 2024. During January, the shortage reached a new 14-year high of Rs 3.3 lakh crore and strained money markets and banks. RBI has also helped bridge this shortage in the foreign exchange market by protecting the rupee from outward volatility, especially under stress conditions in the world economy and uncertainty in trade policy.

The new currency swap is also a component of a wider scheme to relieve liquidity deficiencies. In this scheme, the central bank purchases dollars from banks in return for rupees and undertakes to sell them back later. This scheme injects rupee liquidity into the system in real time.

Impact on Rupee and Money Markets

Despite RBI intervention, the rupee continued to depreciate, which implies persistent pressure on the currency. Following the announcement of the swap auction results, the rupee further weakened and declined 0.3 per cent to 87.4900 per dollar. The currency has been under pressure, having lost 1 per cent in February and hitting an all-time low of 87.9 per dollar. The currency recorded its fifth consecutive monthly decline, due to foreign portfolio flows and higher hedging on the onshore and non-deliverable forward markets. The RBI in the swap auction established a cut-off premium of 655.10 paise. It implies that banks, at maturity of the swap after three years, will have to pay rupees along with the premium on the swap in exchange for receiving their dollars back. The secondary market traded most recently at 698.25 paise, data arranged by Bloomberg showed, indicating continued currency market volatility.

Actions to Infuse Liquidity

Multiple tools have been used by RBI to mitigate the liquidity strain. Apart from currency swaps, the central bank has:

• Purchased open market bonds worth Rs 1 trillion (USD 11.5 billion).

• Provided Rs 1.8 trillion of long-tenor liquidity via repurchase auctions, but these are scheduled to be rolled over in a short while.

• Lowered interest rates previously in February to provide impetus to economic activity.

The liquidity crisis emerges at a period when India's economy is also experiencing growth. The recent moves by RBI reflect its vigilant attitude in settling money markets and providing sufficient liquidity in the system. Yet with continuing global volatilities and a depreciating rupee, the central bank might have to persist with intervention to avoid further dislocations in financial markets.

The overall liquidity injection by RBI in February is valued at USD 47 billion now, one of the largest such initiatives in recent years to inject stability into the finances, as per Bloomberg. While market participants anticipate additional measures to be taken, the success of the measures will be important in defining the direction of India's monetary and exchange rate policies.