Will RBI's actions stabilise the USD/INR fluctuations? If so, how?

Part 2 to the initial article: Overview of RBI's actions

The RBI's measures, including Open Market Operations (OMO) and USD/INR buy/sell swap auctions, are designed to stabilise the USD/INR exchange rate fluctuations indirectly. Here's how these measures can help:

Stabilization of USD/INR Fluctuations

Reduced Rupee Volatility:
- Liquidity Injection: OMOs inject liquidity into the banking system, maintaining confidence in the Indian economy. This confidence reduces volatility in the rupee, as a stable banking system supports economic growth and investor sentiment.
- Impact on USD/INR: A stable financial environment indirectly supports the rupee by reducing sudden currency fluctuations.
USD/INR Swap Auctions:
- Mechanism: The RBI buys dollars from banks in exchange for rupees, providing liquidity buffers and managing forex reserves. This helps mitigate pressure on the rupee during forex outflows.
- Exchange Rate Stability: Swap auctions directly address USD/INR volatility by providing a liquidity buffer, stabilizing the exchange rate.
- Long-Term Liquidity: The recent $10 billion swap with a three-year tenor provides long-term liquidity, supporting credit flow and reducing the risk of sudden currency fluctuations.
Forex Reserves Management:
- The RBI's forex swap operations manage forex reserves effectively. While these operations can temporarily deplete reserves, they ensure the rupee remains stable during high volatility.

FII Outflows and Their Impact

Reasons for FII Outflows:
- Global Economic Conditions: The global economic environment influences FII flows. During economic crises, FIIs shift investments from emerging markets like India to more stable economies.
- Political Instability: Political tensions can lead to FII outflows as investors seek more stable environments.
- Currency Fluctuations: Continuous depreciation or fluctuations in the local currency can prompt FIIs to reallocate their portfolios.
- Attractive Alternatives: FIIs are currently attracted to markets like China, where valuations appear more favourable.
- US Market Attractiveness: Rising US bond yields and the stability of US equities have made them more appealing to FIIs, leading to outflows from India.
Current Market Situation:
- FII Outflows in 2025: FIIs have withdrawn significant amounts from Indian equities, with outflows reaching over ₹1 lakh crore in early 2025. This has led to a decline in key indices like the Nifty and Sensex.
- Market Performance: The Indian stock market has underperformed Asian peers due to these outflows, with the BSE Mid-cap and Small-cap indices experiencing substantial declines.
How RBI Actions Can Help Manage FII Outflows:
- Forex Reserve Management: The RBI's USD/INR swaps help manage forex reserves, which can be used to intervene in the forex market during significant FII outflows.
- Confidence and Sentiment: Maintaining a stable financial system boosts investor confidence, potentially attracting more foreign investment and offsetting some effects of FII outflows.
- Long-Term Liquidity: Long-term USD/INR swaps provide durable liquidity, supporting credit flow and reducing the risk of sudden currency fluctuations.

Conclusion

While the RBI's measures are primarily focused on domestic liquidity, they indirectly support USD/INR stability by maintaining economic confidence and providing liquidity buffers. However, addressing FII outflows more directly may require broader economic policies beyond liquidity management. The current FII exodus from India is driven by global economic conditions, political factors, and the attractiveness of alternative markets like China and the US. Despite these challenges, some experts remain optimistic about India's long-term investment potential.

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