Rupee depreciation: Is RBI intervention deferring the inevitable?

Source: The post  “Rupee depreciation: Is RBI intervention deferring the inevitable?’’ has been created, based on “Rupee depreciation: Is RBI intervention deferring the inevitable?” published in “BusinessLine” on 14th January 2026.

UPSC Syllabus: GS Paper-2- Economy

Context: The Reserve Bank of India (RBI) has used dollar/rupee buy–sell swap auctions as part of its strategy to manage excess volatility in the foreign exchange market, especially as the rupee faces persistent depreciation pressures around the 90/$ level.

Role of swaps in RBI’s intervention strategy

RBI follows a two-pronged approach to currency management:

1. Spot market intervention:
   RBI sells dollars in the spot market to arrest sharp or disorderly depreciation of the rupee. While this helps stabilise the exchange rate, it leads to a withdrawal of rupee liquidity from the domestic financial system.
2. Forward market intervention through swaps:
   To offset the liquidity tightening caused by spot dollar sales, RBI conducts dollar/rupee buy–sell swaps. By buying dollars in the present, RBI injects rupee liquidity into the system. The commitment to sell dollars in the future increases forward dollar supply and helps compress forward premiums. Thus, swaps stabilise both domestic liquidity conditions and market expectations.

Through this mechanism, RBI aligns with its stated objective of curbing “excessive volatility” without explicitly targeting the exchange rate level.

Costs and limitations of continued intervention

Despite its advantages, sustained intervention entails significant costs:

1. Forward liability build-up: Repeated buy–sell swaps lead to net forward dollar sales, particularly at longer maturities, creating future obligations and shifting the cost of intervention to a later date.
2. Reserve dependence: Continuous spot intervention increases reliance on foreign exchange reserves and forward positions.
3. Reduced exchange rate flexibility: Persistent intervention has drawn IMF criticism, with the rupee classified as a crawl-like arrangement, limiting the currency’s ability to absorb external shocks.
4. Moral hazard: Corporates may under-hedge foreign exchange risks, expecting RBI to maintain currency stability.

Challenges

1. Rising forward liabilities: Repeated use of buy–sell swaps leads to accumulation of net forward dollar sales, pushing exchange rate risks and costs into the future.
2. Dependence on reserves: Persistent spot dollar sales increase reliance on forex reserves and forward commitments, reducing policy buffers.
3. Limited exchange rate flexibility: Continuous intervention suppresses natural price discovery, weakening the rupee’s ability to absorb external shocks.
4. Liquidity–inflation trade-off: Rupee liquidity injected through swaps may complicate domestic liquidity management and inflation control.
5. Market moral hazard: Corporates and importers may hedge inadequately, assuming RBI will cap volatility.
6. Inability to offset fundamentals: Structural pressures from weak exports, adverse capital flows, and narrow interest differentials cannot be fully countered by intervention.

Way Forward

1. Allow greater exchange rate flexibility to absorb external shocks and reduce repeated intervention.
2. Strengthen export competitiveness through diversification of markets and products, and reduced trade concentration risks.
3. Improve fiscal discipline and growth conditions to support durable capital inflows and currency confidence.
4. Encourage prudent corporate hedging, especially for large importers, to reduce reliance on RBI for stability.
5. Deepen forex and derivatives markets to improve risk-sharing, liquidity, and price discovery.
6. Use intervention selectively, focusing only on disorderly volatility rather than defending implicit exchange rate levels.
7. Coordinate monetary, fiscal, and trade policies to address the root causes of persistent rupee depreciation.

Conclusion: Dollar/rupee swaps are an effective short-term tool for managing volatility and liquidity. However, durable currency stability requires strengthening domestic growth, improving fiscal management, diversifying exports, and encouraging prudent hedging by firms, rather than relying excessively on central bank intervention.

Question: How do RBI’s dollar/rupee swap auctions fit into its currency stabilisation strategy? Are there costs to such intervention?

Source: Business Line