On January 31, 2022, the Reserve Bank of India (RBI) conducted a foreign exchange (forex) swap amounting to $5 billion. This swap was specifically a dollar-rupee swap with a tenure of six months. However, considering the ongoing economic conditions – the INR and Stock Markets being deteriorated – the RBI has now decided to conduct a larger $10 billion forex swap on February 28, 2025, with a significantly extended tenure of three years. This measure is being undertaken to address several macroeconomic challenges, including liquidity concerns in the banking system, rupee stabilization, and foreign exchange reserve management.
Purpose of the Forex Swap
The RBI’s decision to undertake a $10 billion forex swap serves multiple objectives. Firstly, it aims to address liquidity requirements in the banking system. Indian banks currently require additional liquidity in rupees, and this swap is expected to infuse the much-needed capital. Secondly, the swap seeks to stabilize the value of the Indian rupee. Over the past year, the rupee has experienced significant depreciation, with its value declining from approximately ₹83 per USD to ₹88 per USD. Recently, the exchange rate has been hovering around ₹86.6 per USD. The persistent depreciation of the rupee necessitates RBI intervention to prevent excessive volatility in the foreign exchange market.
Additionally, the forex swap is expected to strengthen India’s foreign exchange reserves, which, despite being above $600 billion, have witnessed a notable decline in recent months. By purchasing $10 billion from banks, the RBI will enhance its forex reserves, which is crucial for maintaining investor confidence and ensuring financial stability.
Mechanism of the Forex Swap
A forex swap is essentially an agreement in which the RBI buys foreign currency (USD) from commercial banks while simultaneously providing them with rupees in return. The banks, which hold significant dollar reserves, accumulate foreign currency when international entities convert their dollars into rupees for transactions within India. However, the current liquidity crunch in the banking sector has led to a shortage of rupees.
Through this swap, the RBI will acquire $10 billion from banks for three years and, in return, supply rupees to them. At the end of the three-year period, the transaction will be reversed—banks will return the borrowed rupees to the RBI, and in exchange, they will reclaim their dollar holdings.
The swap is conducted through an auction process. Banks participating in the auction bid by quoting the exchange rate at which they are willing to sell their dollars to the RBI. The bank offering the most competitive (lower) rupee price per dollar is given preference. The minimum participation threshold for banks is $10 million, with incremental bids allowed in multiples of $10 million. This ensures that the process remains transparent and efficient.
Rationale Behind the Swap
The RBI is undertaking this forex swap for several reasons. One primary factor is the ongoing liquidity shortage in the banking sector. In January 2025, India experienced one of the most significant liquidity crunches in the past decade, with liquidity deficit levels reaching ₹3.15 lakh crore ($36.37 Billion) on January 23, 2025. Although the RBI has attempted to mitigate this issue, there remains a liquidity shortfall of approximately ₹1.7 lakh crore ($19.63 billion.) as of February 28, 2025. The forex swap, injecting approximately ₹86,000 ($9.93 billion) crore into the system, is expected to provide significant relief to the financial sector.
Another critical reason is the depreciation of the Indian rupee. The RBI has previously intervened in the foreign exchange market by selling dollars from its reserves to prevent excessive rupee depreciation. While this strategy temporarily stabilizes the exchange rate, it also depletes forex reserves. The forex swap serves as a complementary measure, replenishing reserves while simultaneously injecting rupee liquidity into the system.
Impact on Interest Rates and Inflation Control
The swap will also influence India’s monetary policy and interest rate dynamics. Recently, the RBI reduced the repo rate by 25 basis points, lowering it from 6.5% to 6.25%. However, despite the rate cut, commercial banks have been reluctant to reduce loan interest rates. This reluctance is largely due to the tight liquidity conditions, which have prompted banks to offer higher deposit interest rates, thereby maintaining high lending rates. An increase in rupee liquidity, facilitated by the forex swap, could gradually reduce deposit rates, leading to a decline in loan interest rates.
Additionally, this forex swap is expected to strengthen India’s foreign exchange reserves, which have declined from over $630 billion to approximately $600 billion due to continuous interventions in the forex market. By purchasing dollars from banks and adding them to forex reserves, the RBI is ensuring a more stable financial environment.
Conclusion
In conclusion, the $10 billion forex swap scheduled for February 28, 2022, is a strategic move by the Reserve Bank of India to stabilize the rupee, address liquidity shortages, and strengthen forex reserves. The auction-based mechanism ensures a market-driven approach, allowing banks to participate efficiently. This move will not only help mitigate immediate economic challenges but also contribute to long-term financial stability in India. As the global economic landscape continues to evolve, such proactive measures by the RBI will play a crucial role in maintaining macroeconomic stability and fostering economic growth.
