New Delhi. After the rupee slipped to a record low last week, the Reserve Bank of India (RBI) has caught the attention of the market by announcing a big liquidity increase. The central bank has prepared a package of rate cut of 25 basis points, open market purchase (OMO) of Rs 1 lakh crore in December and buy-sell swap of $ 5 billion. The question is whether this liquidity support will be able to stop the fall of the rupee or will it only provide temporary relief?
What does RBI’s liquidity injection do?
RBI’s large-scale OMOs inject immediate cash into the banking system. When purchasing government bonds, RBI gives money directly to banks, which increases liquidity in the market and reduces pressure on short-term rates. According to experts, tight liquidity environment often increases pressure on the rupee because foreign investors become cautious in such an environment. OMO of Rs 1 lakh crore is an indication from RBI that no tough environment will be allowed to be created in the funding market.
How will the $5 billion swap work?
Swaps have a more direct impact on the currency market. RBI promises to buy dollars now and sell them later, which brings money into the system immediately but does not put permanent pressure on the reserves. Experts believe that this step directly deals with the fluctuations in the rupee and RBI has got this space from the strength of the macro backdrop. At the same time, the rapid decline in inflation and forex reserves of more than $686 billion have given the RBI the confidence that it can intervene without distorting the policy signals.
Will this support really support the rupee?
Some analysts are surprised that RBI has chosen the path of rate cut amid the new fall in the rupee, but many experts consider it a sign. According to him, the recent fall is an overreaction and the current level of the rupee reflects undervaluation. According to him, the message of RBI is clear that inflation is under control, hence there is ground for stabilization of the rupee.
Liquidity does not lift the rupee directly, but manages the fall
Liquidity support is not a magical solution that will strengthen the rupee immediately. But it reduces market panic and prevents ‘disorderly fall’. Better funding conditions and strong growth support prevent sudden exits of foreign investors. According to experts, rate cut, OMO and swap together create a backstop in all three interest rate, currency and bond channels, due to which the market moves towards stability.
The real challenge is still the global economy
Despite RBI’s efforts, the direction of the rupee will largely depend on global conditions. Factors like the US interest rate cycle, capital flows and geopolitical tensions still weigh heaviest. Nevertheless, in an environment of low inflation and stable domestic growth, the central bank has seized a rare opportunity. Low inflation has given RBI scope for rate cuts throughout the year while funding conditions are also supportive.
The way forward: the bought window of stability
At present, this liquidity step of RBI is an attempt to buy stability and sentiment. Whether there will be a recovery in the rupee will depend on how global cues change. But what is clear is that the stability maintained on the domestic front will prevent the rupee’s weakness from spiraling out of control and will continue to provide a reliable backstop to the market.
