Rupee Plunges to New Low as RBI Takes Contradictory Measures Amid Forex Reserve Surge
The foreign exchange market in Mumbai witnessed a series of seemingly contradictory developments on Friday, creating a complex financial landscape. The Indian rupee tumbled to a fresh record low, the Reserve Bank of India implemented measures to ease borrowing conditions, and the country's foreign exchange reserves astonishingly surged past the $700 billion milestone. This occurred even as the central bank was actively selling dollars in the market to support the weakening currency.
Rupee's Sharp Decline and Weekly Performance
The rupee experienced significant downward pressure, slipping close to the 92 mark against the US dollar before settling at 91.94 at the day's close. This represented a decline of 24 paise, marking the currency's most substantial weekly fall in six months. The depreciation was primarily driven by persistent foreign portfolio outflows, rising crude oil prices that increased import costs, and elevated global bond yields that attracted capital away from emerging markets like India.
While intervention by the Reserve Bank of India helped moderate the pace of the rupee's fall, it could not completely reverse the broader weakness. The currency remained under pressure, particularly as equity markets continued to face selling pressure from foreign investors, creating a challenging environment for monetary authorities.
RBI's Unconventional Liquidity Injection Strategy
Typically, when the RBI sells dollars to defend the rupee, it withdraws rupees from the banking system, leading to tighter liquidity conditions. This tightening usually pushes up short-term interest rates, making it more expensive for speculators to bet against the currency. However, in a departure from this conventional approach, the central bank adopted a different strategy this time.
To prevent borrowing costs from rising sharply and to maintain control over bond yields, the RBI announced comprehensive measures to inject approximately ₹2.15 lakh crore into the banking system. These initiatives included a significant $10-billion dollar-rupee swap arrangement, demonstrating the central bank's innovative approach to managing monetary conditions.
The Dollar-Rupee Swap Mechanism Explained
The dollar-rupee swap arrangement provides crucial insight into what might otherwise appear puzzling. Under this mechanism, commercial banks sell dollars to the central bank and receive rupees in return, with both parties agreeing to reverse the transaction after three years. This innovative approach immediately adds rupee liquidity to the financial system while simultaneously increasing dollar holdings in the foreign exchange reserves.
This explains how forex reserves could expand dramatically even as the RBI might be selling dollars in the spot market to stabilize the currency. As a direct result of these strategic moves, India's foreign exchange reserves climbed sharply to $701.4 billion as of January 16, representing a substantial increase of $14.2 billion in just one week.
Policy Balancing Act in Challenging Times
Collectively, these developments underscore the delicate balancing act confronting Indian policymakers. They must simultaneously address multiple challenges: containing currency weakness to prevent excessive depreciation, keeping interest rates from rising too sharply to support economic recovery, and maintaining a robust reserve buffer that can continue growing even when the rupee faces significant pressure.
The RBI's coordinated actions demonstrate a sophisticated approach to monetary management, employing multiple tools to navigate complex global financial conditions while supporting domestic economic stability. This strategic maneuvering highlights how central banks must sometimes adopt unconventional measures to address competing priorities in volatile market environments.
