Editorial Analysis – 1. The following is the detailed analysis of the Editorial titled “Necessary infusion: On the RBI’s currency swap” published in ‘The Hindu‘ newspaper on February 24, 2025.
Link to the original Editorial – https://www.thehindu.com/opinion/editorial/necessary-infusion-on-the-rbis-currency-swap/article69254778.ece
Necessary infusion: On the RBI’s currency swap [Analysis]
Background note:
The Reserve Bank of India (RBI) is the central bank of the country. All banks in India come under its control. It is popularly known as the ‘Banker of Banks’. It has two major responsibilities. These are ….
- To keep the inflation under control
- To ensure that the exchange value (Or, the price) of the Rupee does not fluctuate wildly, either through sharp increases or through sharp falls.
To enable RBI to discharge its responsibilities properly, it has been given sweeping administrative powers. It’s an autonomous institution that may disregard the instructions of the government if it feels that government’s orders could harm the economy. It has controls over the borrowing of the central and state governments from the country’s banks or from sources outside the country. It decides the interest rates on deposits and loans of banks under its control. It can refuse to print notes to provide for government’s need for money. In a nutshell, RBI controls the Monetary Policies of the country whereas the elected government controls the Fiscal Policies.
Whenever the price of Rupee falls continuously, or rises relentlessly, RBI steps in with its corrective measures. RBI has many options available for it.
If the price of Rupee rises, the importers feel distressed because they have to part with more rupees to get their requirement of foreign currencies like the US Dollar. When the price of Rupee falls as is happening these days, exporters feel happy because they get more rupees for their foreign exchange (USD) earnings.
Rupee’s value in the international (its exchange rate) market fluctuates every minute of the day on a 24×7 basis. If the fluctuation is within limits, no one bothers. But, if it continuously rises or falls, danger bell starts ringing for the RBI.
Presently, the value of Rupee has been falling continuously. Its exchange rate against the American Dollar has crossed 87. This means, to get one USD, one has to deposit Rs. 87 in their bank or the foreign exchange dealers. In fact, Rupee’s value has decreased by about 3.8% in the last three months. This is both alarming and hurtful for the economy.
Normally, when Rupee’s value falls, it implies that too much rupee and too less dollars are available in the country’s currency market. To correct such imbalance, RBI comes forward with its dollar holdings (money bag of dollars) and sells it to whoever wants dollars. With such increased availability of Dollars, its value falls, and the price of Rupee increases. At least, Rupee’s further fall is arrested. Some stability in the exchange rate gets restored.
The opposite happens when the price of dollar falls and Rupee rises. In such a scenario, RBI offers to buy up dollars from the market, thus decreasing its availability. Consequently, Dollar price increases and Rupee price falls.
Normally, RBI does not like to intervene in such manner. It wants market forces to determine Rupee’s exchange rate. Only when the fluctuation becomes too high, the RBI steps in. In the present times, RBI has already tried this weapon.
The continuous slide in Rupee’s value has been due to a combination of factors, some internal, some others originating in the United States after Trump’s disruptive economic policies). Anyway, the surging value of the Dollar vis-à-vis Rupee has created other problems for India’s economy. One of them is ‘Liquidity crisis’
What is Liquidity Crisis?
Before we understand Liquidity Crisis, we must understand how foreign investment (money) comes in and goes out of India. Foreign investment comes in two ways.
1. Foreign Direct Investment (FDI)
2. Foreign Institutional Investment (FII)
What is FDI?
It is the investment foreign parties make to start factories, set-up businesses, develop infrastructure etc, So, FDI is necessarily long-term. It creates new jobs, boosts manufacturing and exports, adds to the revenue earning of government. The investors bring in new technology, and better management practices, to the country. When they begin to make profit, they repatriate a part of it (repatriate) to their country of origin, and reinvest the rest in expanding their businesses here. Over all, FDI is considered to be welcome. The government goes out of its way to woo FDI sources to come here.
What is FII?
These are the investors who invest their money in the stock market to make some quick profits through trading in shares. Such investment is very volatile. An investor come in with, say, Rs.1000 crores today, and go back with the entire investment in a month or even less. They take back their money to invest in other stock markets in other countries. Such investors, no doubt, boost the share market activity, but they can and do inject a lot of anxiety among other investors. So, FII inflow is welcome, but its impact on economic growth is minimal.
What factors have contributed to RBI’s headache in recent weeks?
President Trump’s disruptive economic policies, especially his tariff enhancement threats, have created anxiety worldwide. India’s stock market indices have fallen due to the adverse sentiments created by Trump’s policies. On the contrary, sentiments inside the U.S. have become positive as they feel that American economy will get a boost due to their president’s initiatives. The U.S. stock prices have risen boosting the US Dollar. As the Dollar rises, Rupee falls. This is one reason why Rupee is falling continuously.
Rise in U.S. stock prices have made investment there more lucrative for investors. This has prompted the FIIs to withdraw their investments from India, and take them to the U.S. When they leave, they take their money in Dollars, not in Rupee form. Withdrawal of vast sums in Dollar form depletes the RBI’s dollar holdings. Once this happens, the availability of dollar in Indian currency market falls. Consequently, dollar prices shoot up causing a falling Rupee value.
There are a few internal factors that have put pressure on the RBI. It has to stabilize Rupee at any cost.
What RBI is contemplating to do –
One major step RBI has taken in the last few days is to go for a Currency Swap. Under this arrangement, RBI can ask different banks in India to give their dollar holdings to RBI for a certain period under a certain agreement. In return, RBI gives them rupees in exchange. Banks become flush with rupees which they can lend to their borrowers to set up new ventures or expand their existing ones. Thus, Currency Swap yields two types of benefits.
1. RBI’s Dollar holdings go up after the currency swap. So, it can offer it to needy parties who want to import items. For example, Indian Oil imports crude oil periodically. It has to make payments to the seller in dollars. When it approaches for dollars (in millions), RBI can give the dollars to Indian Oil without any difficulty. Such ease of selling dollars to needy parties is possible when there is enough Liquidity in the currency market. In the same way, a large borrower can get its loan sanctioned and disbursed by its bank easily because the bank has enough rupees with it (obtained from RBI under the Currency Swap arrangement). Thus, the economy begins to enjoy the benefits of liquidity. If banks don’t have enough rupee reserves, they will restrict lending till their liquidity improves. They enforce Credit Squeeze (stopping further lending) till their liquidity improves.
2. When the RBI has enough dollars to sell, the price of Rupee stabilizes. Rupee’s exchange rate vis-a-vis the Dollar does not change much. This stabilizes the currency market and helps the economy to continue its growth.
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