RBI Swap Window Boosts India’s Forex Reserves, Strengthening Rupee Defence

The Reserve Bank of India’s special foreign exchange swap facilities have attracted around $136.3 billion by the end of August, significantly higher than market expectations and potentially taking the country’s foreign exchange reserves beyond the $750-billion mark, according to a DBS Bank report.

The sharp rise in dollar inflows is giving the central bank greater room to manage volatility in the currency market and support the rupee during periods of depreciation. The impact was already visible in recent trading, with the USD/INR pair falling sharply and testing levels below Rs 95, moving into the mid-Rs 94 range amid strong dollar selling by the RBI and broader movements in the US currency.

Around 92 per cent of the total inflows, or approximately $126 billion, came through foreign currency non-resident (FCNR-B) deposit-related arrangements, while the remaining inflows were generated through offshore borrowing facilities.

DBS Bank senior economist and executive director Radhika Rao said the swap arrangements would also add to domestic rupee liquidity, which was already at a four-year high. The resulting surplus liquidity could put downward pressure on overnight interest rates, creating another policy consideration for the central bank.

However, the additional liquidity may not remain unchecked. Tax-related fund movements, seasonal currency leakage, a current account deficit estimated at around 1.1 per cent of GDP, portfolio outflows and the maturity of existing forward positions could absorb part of the excess liquidity. The DBS report said coordinated measures may nevertheless be required to prevent a substantial liquidity build-up.

The report also pointed to a future challenge arising from the concentration of deposit maturities in the three-year and five-year segments. When these deposits mature, they could potentially generate additional demand for dollars if funds are repatriated or converted.

To reduce that risk, the report suggested that part of the existing foreign exchange reserve stock could effectively be set aside against such liabilities. This could reassure markets that upcoming deposit maturities and external debt repayments are unlikely to result in a sudden surge in dollar demand.

Currency traders currently expect the rupee to remain within an immediate range of around Rs 94.10 to Rs 95.50. A sustained break below Rs 94.10 could open the possibility of the rupee strengthening further towards Rs 93.50.

Market participants expect the RBI to use the improved reserve position to rebuild its buffers while limiting excessive depreciation of the domestic currency. The rupee is also receiving support from broader strength in Asian currencies and a decline in the US dollar index, with a rally in the Japanese yen contributing to the move.

The latest developments underline the importance of the RBI’s swap operations beyond their immediate impact on foreign exchange reserves. While the inflows provide a larger dollar cushion and greater capacity for currency-market intervention, they also create a substantial rupee-liquidity management challenge that the central bank will need to balance in the months ahead.