The Indian rupee closed at a 10-week high on Thursday, 3 September, after Indian banks mobilized a record $136.38 billion through special Reserve Bank of India (RBI) foreign-exchange schemes. The inflows have strengthened the central bank’s ability to manage currency volatility, but have also pushed domestic banking liquidity to an unprecedented surplus.

Banks raised $127.23 billion through Foreign Currency Non-Resident (Bank), or FCNR(B), deposits, $5.26 billion through overseas foreign-currency borrowings and $3.89 billion through external commercial borrowings as of 31 August, according to provisional RBI data.

The total is more than five times the roughly $26 billion raised through a comparable program during India’s 2013 currency crisis. It also exceeded economists’ expectations of $80 billion to $90 billion.

The FCNR(B) window, originally scheduled to remain open until the end of September, closed early on 31 August after the stronger-than-expected response. Facilities covering the other two forms of borrowing remain open until 31 December.

How the inflows support the rupee

Under the program, banks sell newly raised foreign currency to the RBI and receive rupees. The transactions are reversed when the swaps mature, with the RBI returning the principal in foreign currency at a pre-agreed forward rate.

The arrangement shields banks from much of the exchange-rate risk on the principal while placing the dollars temporarily with the central bank. The RBI says the swap covers the principal but not the interest payable on the deposits.

The inflows increase the RBI’s gross foreign-currency resources and its capacity to contain disorderly movements in the rupee. India’s foreign-exchange reserves reached a record $729.33 billion in the week ended 21 August, before much of the late-August mobilization was reflected in the published figures.

The rupee closed at ₹94.4850 to the dollar on Thursday, its strongest finish in 10 weeks. It gained about 0.5% from ₹94.97 in the previous session, its largest daily advance since 27 July, Reuters reported.

The additional dollars give the RBI more room to counter pressure from high oil prices, capital outflows or a stronger US currency. They do not remove those risks. Costlier crude could still widen India’s trade deficit and increase demand for dollars from importers.

Banking liquidity reaches a record

The other side of the transaction is a large injection of rupees into the banking system. When the RBI acquires dollars through the swaps, it credits participating banks with domestic currency.

Banking-system liquidity consequently reached a record surplus of about ₹9.7 trillion, or $102.7 billion, on Thursday, surpassing the previous peak of ₹9.2 trillion recorded in September 2021, according to Reuters.

The excess cash has pushed overnight money-market rates below the RBI’s 5.25% policy repo rate, complicating the transmission of monetary policy. If the surplus persists, cheaper short-term funding could also encourage faster credit growth and make inflation management more difficult.

The RBI can absorb liquidity through variable-rate reverse-repurchase auctions or coordinate sales of short-term government securities. Economists have also raised the possibility of a temporary incremental cash reserve ratio, which would require banks to park part of the additional funds with the central bank.

The RBI used such a requirement in 2023 after the withdrawal of ₹2,000 banknotes produced a sudden rise in banking liquidity. Using it again would absorb cash quickly but could restrict lending and raise funding costs for banks.

The dollars must eventually be returned

The swap inflows strengthen the RBI’s immediate spot position but do not represent permanent additions to its usable reserves.

Deposits eligible under the FCNR(B) facility have maturities of three to five years. When the swaps expire, the RBI must return the foreign-currency principal to banks in exchange for rupees.

The central bank’s overall net short-dollar forward position rose to a record $136.77 billion at the end of July from $103.33 billion a month earlier. About $91.54 billion of the short position had a maturity exceeding one year, data showed.

The forward book includes more than this deposit program, so it should not be treated as a direct measure of the scheme’s future cost. It nevertheless represents a substantial obligation to deliver dollars later.

The maturities are distributed over several years, and the RBI can meet, offset or roll over the positions. During periods of rupee strength, it may also buy dollars to reduce its forward exposure, potentially limiting the currency’s appreciation.

The program therefore gives the RBI a larger near-term buffer against oil shocks and capital outflows while creating two issues to manage: record rupee liquidity today and substantial dollar commitments in the years ahead.