RBI Rupee Defence and Liquidity Squeeze in Banks

18 February 20251 min read

Why in the news

RBI’s efforts to slow the rupee’s fall are tightening rupee liquidity just when the economy needs support, straining its monetary policy.

Selling dollars from forex reserves pulls rupees out of the system, tightening liquidity.
The banking system flipped from surplus to deficit liquidity, limiting lending.
FX reserves fell from $704 billion to $630 billion over September to January, creating a ₹1.2 trillion deficit.
RBI lent to banks and bought government securities through open market operations, but relief was small.

A repo cut signals easing, yet heavy forex activity keeps liquidity tight and lifts WACR.
RBI pursues two opposing goals: exchange-rate stability and easing.
Suggested fix: focus directly on inflation and growth, letting the rupee clear freely with minimal intervention.

1. What happens to rupee liquidity in the banking system when RBI sells dollars from its reserves to curb rupee depreciation?

Dollar sales suck rupees out of the system and tighten liquidity.

2. RBI's FX reserves fell from $704 billion to what level during the period discussed, causing a ₹1.2 trillion liquidity deficit?

Reserves dropped from $704 billion to $630 billion.

3. Which RBI tool involved buying government securities to add rupee liquidity, with limited impact in this episode?

RBI used open market operations to buy government securities.