
RBI to continue interventions in forex market, despite tight liquidity

Summary
- Under governor Shaktikanta Das, RBI held the currency within a narrow band. But in the past two weeks the rupee has been allowed to slide more freely.
Tight liquidity will not bind the Reserve Bank of India’s (RBI) hands in intervening to curb excessive rupee volatility in the forex market, said a senior official aware of the thinking at the central bank.
"Liquidity will be managed and so will excessive currency volatility," he said. "We have the experience and the tools to manage both."
His comments come in the wake of a perceptible shift in the RBI's defence of the rupee, as observed by market participants. During the earlier regime under governor Shaktikanta Das, RBI held the currency within a narrow band. But in the past two weeks the rupee has been allowed to slide more freely.
For instance, while the dollar index—greenback versus six currencies like Swiss franc, euro and yen—appreciated by 7% last year to 108.48, the rupee dipped just 2.88% to 85.61.
Rupee vs dollar
In the month through 15 January since governor Sanjay Malhotra took the helm at the central bank, the rupee has depreciated by 0.87% to 86.36 against the dollar index's 0.56% appreciation to 109.09.
"There is a change in the way the volatility is being managed, which is visible in the past two weeks, where the local unit has been freed from a narrow range it was constricted to under the previous dispensation," said a senior treasury official at a private sector bank.
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The official said the very aggressive positioning of the RBI on the offshore market (NDF) was likely to be eased, with transfers (of dollar) from the offshore to the onshore market gaining pace in the past two weeks. The central bank intervenes in the NDF market to manage rupee volatility without depleting a large amount of forex reserves until the maturity of the contract.
“This is visible in a surfeit of dollar and a crash in cash tom rates, with RBI covering dollar shorts in the NDF market and selling these dollars on the onshore forward market," the official added. Cash tom refers to the rate to maintain dollar positions overnight.
Forex to the rescue
The interventions in the past few months by the RBI has taken a toll on India's forex reserves, which fell by $70 billion to $634 billion in 14 weeks through 3 January.
While liquidity management will not be a constraint for RBI to intervene in the forex market, bankers believe that the central bank will have to infuse long term durable liquidity. The system liquidity has been in deficit of over ₹2 trillion since 10 January.
Bankers have suggested liquidity measures like forex swaps or open market operations (OMO) by buying and selling government securities in the open market or through a cut in cash reserve ratio (CRR)—the proportion of deposits that banks must keep with the RBI in cash.
“Till now RBI has been infusing short term rupee liquidity through 14-day or 4- or 5-day term repo auctions, through which they lend to banks for the short term. RBI will need to infuse a significant amount of liquidity at least in the form of a 1% cut in CRR," said another treasury dealer.
Stabilising currency market
Governor Malhotra will be meeting the Fixed Income Money Market Association (FIMMDA) and Foreign Exchange Dealers' Association of India (FEDAI) next week as part of pre-policy consultations, where these issues will be discussed.
RBI under governor Das had come under severe criticism from many quarters including the International Monetary Fund (IMF) for its exchange rate management. In December 2023 IMF had reclassified India's "de facto" exchange rate regime to "stabilized arrangement" from "floating" for December 2022 to October 2023, following RBI's likely forex interventions where the rupee traded in a “very narrow range". During Das' term, forex reserves had surged from $393.735 billion on 7 December 2018 to a high of $705 billion in the fortnight ended 27 September 2024, before it declined to $652 billion on 13 December 2024.
Governor Das had then defended the RBI's forex stance by saying, “We didn’t pick the reserves just to keep it as a showpiece. We picked it only for this rainy day."