Dollar-Rupee Buy-Sell Swap Arrangement

GS 3 – ECONOMY

Context: The Reserve Bank of India (RBI) is set to inject rupee liquidity for an extended period through another $10 billion dollar-rupee buy-sell swap.

It’s a tool used by the RBI to manage liquidity and support the rupee’s value.

How does it work?

• The RBI buys U.S. dollars from banks, giving them rupees in return, which adds liquidity to the system.
• After a set period, the RBI sells the dollars back, taking the extra rupees out of circulation.

Why is it done?

• Manage Liquidity: Controls the flow of rupees in the economy.
• Stabilize Rupee: Reduces pressure on the rupee during foreign fund outflows.
• Control Inflation: Helps influence interest rates and curb inflation.
• Increase Dollar Reserves: Strengthens RBI’s dollar stockpile for future forex interventions.

Liquidity Crunch in Indian Banks

Indian banks faced a major liquidity shortage, peaking at Rs 3.15 lakh crore on January 23 — the worst in nearly 15 years.

Why did this happen?

1. Tight Monetary Policy: Higher repo rates and liquidity-absorbing measures.
2. RBI’s Dollar Sales: Selling dollars to stabilize the rupee reduced rupee liquidity.
3. Tax & GST Payments: Regular tax outflows temporarily locked cash.
4. Foreign Fund Outflows: Prolonged foreign investor exits strained liquidity.

RBI’s Steps to Boost Liquidity

• Open Market Operations (OMO):
  • RBI will buy ₹60,000 crore in government bonds (₹20,000 crore in three tranches) to add liquidity.
• Cash Reserve Ratio (CRR) Cut:
  • Reduced by 50 basis points to 4% in December 2024, freeing up more funds for banks.
• Repo Rate Cut:
  • Lowered by 25 basis points to 6.25%, making borrowing cheaper and boosting liquidity.
• Variable Repo Rate (VRR) Auctions:
  • RBI held ₹50,000 crore (56-day) and ₹75,000 crore (49-day) VRR auctions to inject funds.

What is Variable Repo Rate (VRR)?

• A flexible tool under RBI’s Liquidity Adjustment Facility to manage short-term liquidity, with rates decided through market-based auctions.
• Tenure: Ranges from 2 to 14 days or longer.
• Function: RBI can conduct overnight or longer-term repo auctions based on market needs.

Why is VRR Important?

• Controlling Inflation: VRR helps absorb excess liquidity to curb inflation.
• Easing Liquidity Shortages: During liquidity crunches, the RBI can adjust VRR or increase auctions to pump more money into the banking system.

Mains Questions:

Discuss the role of the Dollar-Rupee Buy-Sell Swap Arrangement as a tool for managing liquidity and stabilizing the Indian rupee. How does it complement other RBI measures in addressing liquidity shortages? (250 words)