How India's RBI could tackle a liquidity deluge triggered by dollar deposits

According to Business Recorder, India's central bank received $127.23 billion through its special dollar deposit programme, more than it had anticipated. Lenders converted these dollars into rupees through direct trades with the RBI, which lifted the banking system's surplus cash to a record 9.70 trillion rupees, or $102.70 billion. Traders are now debating how the RBI could soak up the extra funds without stoking inflation that is already climbing.

One option is longer-term reverse repo auctions that banks could exit early, a format a primary dealership trader said had worked reasonably well earlier in the year. Another is dollar-rupee swaps, where the central bank sells dollars or takes delivery of part of its forward book. Emkay Global economist Madhavi Arora said the RBI may be comfortable accepting about $32 billion from forward contracts maturing in one year. A market stabilisation scheme, last used in 2017, would have the government sell short-tenor Treasury bills, though it typically dislikes the tool because it must pay interest.

The cash reserve ratio, now 3%, is the most common tool, and market participants estimate a 50 basis point increase could drain about 1.4 trillion rupees. Open market bond sales would also withdraw liquidity but push yields higher, according to Kotak Mahindra Bank's Upasna Bhardwaj, who expects most sales to focus on the three-year to 10-year range.