Liquidity Impact of RBI Currency Management

Beginning with November, the RBI has been allowing the rupee to depreciate against the dollar after exiting last two years of effective peg. Though the RBI intervenes to stop further depreciation, it is placing further pressure on the bank’s monetary policy and liquidity in the economy where support is otherwise most needed.

Key Highlights:

• Currency Swap
  • In order to control the depreciation of the rupee, the RBI has sold dollars from its foreign exchange reserves. It has, therefore, sucked rupees out of the system and tightened liquidity.
  • As a consequence, the change has transformed the banking system of India from surplus liquidity to deficit affecting the capability of the banks to lend and conduct business.
• Liquidity Squeeze
  • The RBI dollar sales from September 2023 to January 2024 decreased its FX reserves from $704 billion to $630 billion and caused health to the bank with a liquidity deficit of ₹1.2 trillion.
• What the RBI did
  • The central banks lent to banks and carried out open market operations by purchasing government securities to recapitalize the deposits. However, this has done little to ease up liquidity.
• Mixed Signals
  • Repo cuts in February 2024 signify monetary easing is on the RBI’s mind, however, its robust FX activities maintain liquidity pressures, driving up WACR and further clouding market communication.

Mixed messages given by the stance of RBI result in mixed signals as they are holding on to the two opposing objectives of stability in exchange rate with monetary easing. RBI should pursue inflation and growth directly in the interest of price now stable and growth thinking of the rupee almost in a market sense allowing it to clear freely having minimal interventions.