There has been a perceptible pivot in the management of liquidity conditions by the Reserve Bank of India since December 2024. Before we describe the pivot, first, a brief backdrop.

India experienced an FX squeeze between October 2024 and February 2025, primarily due to adverse global factors. During this period, the rupee weakened from ₹83.79 to ₹87.40 against the dollar. It would be fair to say that the rupee's depreciation would have been greater had the RBI not stepped in with heavy foreign exchange intervention.

Although the forex market situation in India has stabilised since then, the domestic money market faced the collateral damage of the forex market intervention, with rupee liquidity drying up at a fast pace.

With the central bank acknowledging the drain on domestic liquidity from its forex interventions, it started infusing durable liquidity from December 2024 onwards with a cut in the Cash Reserve Ratio, followed by government bond purchases under its Open Market Operations and conduct of Buy-Sell FX Swaps, in subsequent months.

Surprisingly, the RBI’s durable liquidity infusion had a delayed and a slow start.

Between October 2024 and January 2025, there was a net liquidity outflow of ₹5.9 trillion on account of forex interventions and seasonal demand for cash. Out of this, the central bank replenished just ₹1.7 trillion via CRR cut and OMO purchases. Durable liquidity inflows were clearly lagging liquidity outflows during this phase.

This resulted in a perverse situation where, despite explicit monetary policy easing, short-term rates began to rise.

To address this, the central bank accelerated its operations to inject durable liquidity from February 2025, thereby strongly telegraphing its preferred pivot. Between February and April 2025, the central bank injected ₹5.6 trillion, significantly higher than the estimated outflow of ₹1.9 trillion during this period.

With this, the cumulative durable liquidity injection of ₹7.4 trillion by the RBI between October 2024 and April 2025 was adequate to broadly neutralise the cumulative outflow of ₹7.8 trillion seen during this period.

The money market rates stabilised as liquidity pressure eased, with the overnight call rate at 15 bps below the policy repo rate.

Market participants were convinced that the combination of monetary policy easing along with liquidity augmenting measures was enough to nudge interest rates lower sooner rather than later.

Then comes the announcement of ₹1.25 trillion OMO purchases for May 2025 – this ‘peace time’ liquidity intervention came as a pleasant surprise to market participants.

While ‘more is better’, one needs to investigate the underlying thought process and assess if the central bank’s liquidity pivot has acquired greater heft, or whether the policymaker is merely creating safety nets for the near future.

Shadow Reserve
Speaking of safety nets, one observes that the RBI’s forward reserve position showed a record-high net short position of $89 billion as of February 2025.

This massive short position was built between October 2024 and February 2025 as the RBI distributed its forex intervention between the spot and derivatives markets. 

For quick reference, between October 2024 and February 2025, the RBI

• Sold $57 billion in spot
• Sold $74 billion in forwards

While spot intervention by the RBI has an immediate liquidity impact, intervention via forward postpones the impact until the end of the contract period. Imagine what would have transpired on liquidity conditions if the RBI's entire sale of $131 billion during October 2024 and February 2025 had taken place via the spot route!

Now, the injection of durable liquidity by the RBI so far has been instrumental in sterilising the impact of past spot intervention.

However, the chickens from the forward book would come to roost in 2025–26. To be sure, the central bank can potentially roll them over and kick the can down the road. However, the current environment offers an opportunity to lighten this forex reserve liability.

With the dollar remaining weaker and impressive marked-to-market gains on gold reserves in recent months, the RBI could retire this liability without any perceptible dent to its headline forex reserves.

The settlement of a short forward position will immediately drain liquidity and decline headline forex reserves. While the current market environment could help mask the decline in headline forex reserves with valuation gains from other sources, durable liquidity infusion from the RBI could once again help sterilise its liquidity impact.

How much durable liquidity does the RBI need to inject to sterilise the impact coming from the unwinding of its short forward position?

That’s difficult to assess as the extent of unwinding is a strategic call that the central bank would take depending on market conditions. However, if one assumes a 50% settlement rate, which implies that the remaining 50% gets rolled over, then the RBI could look at retiring $25 billion–$30 billion of its net short forward position by February 2026.

This would require a concomitant durable liquidity injection of ₹2.1 trillion–₹2.5 trillion at current exchange rate. The RBI has announced half of it to take place in May 2025. The remainder could happen during the course of the year, calibrated with the upcoming maturities of forward contracts.

While that explains one of the motives for scaling up liquidity infusion, what if there are other birds to be aimed at?

The global economic backdrop is marked by heightened uncertainty in the Trump 2.0 regime. Global growth outlook is gloomy – most multilateral bodies expect World GDP growth to see a 50–60 bps slowdown in 2025.

This will have a spillover impact on India too. However, this is not going to be a conventional business cycle slowdown.

Monetary policy can serve as an antidote; however, tempering it with liquidity could enhance the flavour. Indeed, taking liquidity surplus above 1.0% of NDTL in May 2025 on the back of announced OMO purchases and anticipation of a record high dividend transfer will hasten the monetary policy transmission and extract a bigger bang for the same buck.

One can continue to weigh the possibilities for now and hope to become wiser with time.