A Proposal for Strengthening the RBI’s Market Operations

The Reserve Bank of India engages in market operations across spot and derivative segments of the foreign exchange market. Its interventions are two-sided and intended to ensure that the market is liquid and deep, and, given its developmental role, that it is functioning in an orderly manner. In keeping with prevailing best practices promoted by the standard-setting body, which is the International Monetary Fund, full information on these transactions is released in the public domain within the prescribed timeliness (a lag of two months). 

In fact, it is the combination of this even-handedness and transparency that convinced the US Treasury to take India out of its watchlist of currency manipulators.

However, the IMF has descended into the perverse practice of labelling. More on that later.

As a result of the RBI’s market activity, the volatility of the rupee’s exchange rate, whether extracted from options prices or calculated from rolling standard deviations or as generalised autoregressive conditional heteroscedasticity (GARCH) estimates has been steadily declining in peace time as well as through the period of synchronised and aggressive monetary policy tightening in 2022-24, the episodes of financial turbulence in 2024 and the tariffs of 2025. 

Consistent with the underlying fundamentals of a moderate saving-investment gap, which is reflected in the current account deficit, the rupee tends to depreciate by about 4-5% annually. The track record shows that the RBI has never resisted this order of movement; it has effectively enabled a glide path rather than jerky plunges or downshifts. It must continue to perform this role to ensure financial stability and in keeping with its role as regulator and developer of the financial markets under its watch.

$1 Trillion In Reserves
For this purpose, the RBI must ensure that it has the wherewithal and the staying power in terms of intervention capacity.

This involves two calculations.

First of all, the RBI must ensure that foreign exchange reserves cover all contractual debt service payments of residual maturity of one year. By current calculations, this could work out to $300 billion-$350 billion. Secondly, the reserves must also always be enough to cover at least 60-65% of the stock of foreign portfolio investment at current market valuation. This is because foreign portfolio outflows can be large and persistent multi-year phenomena, as India has painfully learned since 2022-23.

Back-of-the-envelope estimation suggests that this cover could be of the order of $600 billion-$650 billion. Accordingly, the target level of India’s foreign exchange reserves should be at least $1 trillion. At least, because it will involve an assessment of how much of it is going to be the liquid component for intervention purposes. The level of reserves is also important from a market sensitivity point of view. Punting against such a level should be beyond the reach of the opportunistic and/or the faint-hearted.

In this context, a continuous assessment of capital flows at risk, as described earlier, and simulations of adverse scenarios are essential. The required accretion to the reserves is envisaged over a three-year period, consistent with the 20-year average reserve money expansion of $60 billion-$65 billion per annum to meet the domestic liquidity requirements of the economy.

In order to keep liquidity conditions consistent with the monetary policy stance, sterilisation of the order of $35 billion per annum can easily be done under the uncollateralised standing deposit facility (SDF) to ensure price stability and the orderly evolution of financial markets. Technically, the SDF provides the RBI with infinite sterilisation capacity. Other options for sterilisation can also be considered, depending on evolving financial conditions.

Dollar Repos
In the interregnum, a placeholder is needed. For this, the RBI must plan to activate its holdings of US treasuries, which, at $190 billion, are the 15th largest, according to the US Department of the Treasury.

The Federal Reserve established a repurchase agreement facility for foreign and international monetary authorities (FIMA) in March 2020 upon the declaration of COVID-19 as a pandemic. The objective was to create a backstop source of temporary dollar liquidity to address pressures in global dollar funding. FIMA account holders can enter into repurchase agreements with the Federal Reserve Bank of New York to temporarily exchange their US Treasury securities for US dollars, which can then be made available to institutions and markets in their own jurisdictions. 

It does not involve sales of the securities, only a temporary repo, overnight, which can be rolled over, and up to seven calendar days. The repos are priced at the minimum bid rate for the Fed’s Standing Overnight Repo rate at about 3.75% or at a rate equal to that on overnight index swaps of weekly maturity plus 25 basis points for a seven-day repo. The Fed is responsible for all aspects of post-trade clearing, settlement and collateral management. The FIMA is offered to a broader range of central banks and official institutions than to the set of swap counterparties.

The RBI can then provide US dollars to the foreign exchange market in India through overnight to seven-day repos/sell-buy swaps/outright forwards by matching the maturity of its access to FIMA. This will obviate interest rate risk. If it can conduct these operations on a CCIL platform, it will minimise counterparty risk.

The best results or the biggest bang for the buck can be obtained if the RBI announces a standing forex auction window, and also that it has access to a FIMA facility.

In July 2021, the Fed made FIMA a standing facility. Regular usage of the FIMA by the RBI will eventually pave the way for a regular swap line with the Fed once the latter realises that uninterrupted provision of dollar liquidity to the market in India has a stabilising influence and that it precludes precautionary sales of US Treasury securities in New York, which can be destabilising for the markets there.

Information available on the FIMA is scanty as the Fed does not publish data on counter parties in order to respect their requirements of confidentiality, if any. Responses to the Reserve Benchmarks survey of CentralBanking.com, a global information service providing news, analysis, benchmarking, and training for central banks, financial regulators, and related professionals since 1990, and a few papers published by the Fed’s staff show that the facility has helped stabilise US dollar funding markets. It has brought about reductions in FX swap basis spreads as well as in the sensitivity of the latter to daily changes in risk sentiment proxied by the VIX index. Some respondents also reported stabilisation of capital flows to their economies on announcement effects.

Of the central banks participating in CentralBanking.com’s surveys, 29% requested and gained access to FIMA. Some 44% were from the Americas, 27% from Europe, 20% from Asia and 18% from Africa. The Bank of Mexico regarded it as a useful backup that reassures markets, especially when market conditions are not normal. It also prevents the selling of US treasury securities at disadvantageous prices, as Bank Indonesia observed. The South African Reserve Bank, the Central Bank of Colombia and the Central Bank of Chile have also secured access to the FIMA but have not drawn on it. All of them have, however, welcomed it as a useful tool to access liquidity in US dollars. The Central Bank of Chile did not view FIMA as an alternative to holding a robust level of reserves, prioritising reinforcing its portfolio. Overall, respondents believed that FIMA has been useful in providing support to countries that lack access to swap lines.  

This article is Part IV of a six-part series on exchange-rate policy by Dr Michael Debabrata Patra.

Part I set out the competing narratives on the rupee and the case for exchange-rate stability. Click here.
Part II examined why floating exchange rates have often amplified crises in emerging economies. Click here.
Part III examined Why Central Banks Intervene and why the FX Rate Matters for the RBI. Click here.
Part V will assess why the IMF’s evolving surveillance and labelling practices risk undermining exchange-rate stability rather than preserving it.
Part VI will bring the argument full circle, asking what India’s fundamentals imply for the rupee, stability and policy credibility in an uncertain world.