While the Reserve Bank of India’s (RBI’s) forex interventions are primarily done to manage the currency, they lead to big swings in the banking system’s liquidity. Dollar purchases by the central bank infuse rupee liquidity into the system and vice versa.
Of course, the two tools are used depending on whether currency management or liquidity management is topmost on the agenda. Even so, activity in one of them has a bearing on the other.
Ergo, the planned quantum of bond purchases by RBI in February indicates that the central bank did not have much work in the forex market in the past two months. RBI has committed to buy ₹37,500 crore worth of bonds this month. While that is lower than the ₹50,000 crore it had bought in the previous three months, open market operations (OMOs) remain high.
RBI was a net buyer of dollars in early 2018 and its bond purchases were limited, given the infusion of rupee through the forex route. However, that changed as the central bank turned a net seller of dollars in the spot market and also progressively reduced its long dollar positions in the forward market. This increased the need to infuse liquidity through purchase of domestic assets, or in other words, bonds. The quantum of bond purchases has increased since September because of the reduced long dollar positions.
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