Why the RBI Uses Buy-Sell FX Swaps and What They Really Mean

When the Reserve Bank of India announced another buy-sell dollar-rupee swap auction, markets quickly read it as a signal on the rupee’s direction. Forward premiums jumped, banks recalibrated positions, and speculation about the central bank’s exchange-rate comfort resurfaced. Such reactions miss the point. Buy-sell swaps are not a currency call. They are a liquidity and hedging instrument, designed to manage domestic conditions while conserving foreign exchange reserves.

At their core, buy-sell swaps are liquidity management and risk-hedging instruments.

Their impact on the exchange rate is incidental, not directional, and participation levels do not provide a reliable signal on the rupee’s trajectory.

How do buy-sell swaps work in India?
In a buy-sell swap, the RBI buys dollars in the spot market and simultaneously agrees to sell them back at a future date at a pre-agreed premium. The transaction injects rupee liquidity into the banking system. The forward leg ensures that the operation is automatically unwound at maturity.

For banks, corporates, and foreign investors with foreign currency exposure, the auction also provides a medium-term hedging window. Corporates with external commercial borrowings and foreign portfolio investors holding rupee bonds are natural counterparties, accessing the swap through authorised dealer banks.

Why not intervene in the spot market?
Although flexible exchange rate regimes presume minimal intervention, short-term currency movements frequently diverge from macroeconomic fundamentals. Capital inflows as well as outflows are determined by both global external conditions (“push” factors) and domestic factors (“pull” factors), which remain consistently volatile. 

Spot intervention directly alters foreign exchange reserves and often requires subsequent sterilisation to manage excess liquidity. Swaps, by contrast, allow the central bank to influence liquidity conditions and provide hedging capacity while conserving reserves and maintaining balance-sheet flexibility. This has made them an increasingly preferred tool across emerging markets.

What does international experience show?
Brazil provides a useful comparison. After adopting inflation targeting and a flexible exchange rate in 1999, the Brazilian central bank initially relied on spot intervention, accumulating reserves to around 18% of GDP by 2012. From 2013 onwards, the intervention shifted decisively towards FX swaps, which were frequently deployed during periods of market stress.

The stock of swaps expanded during episodes of volatility and was unwound as conditions stabilised, without signalling a view on the currency’s long-term level. At times, spot sales were combined with swaps to manage volatility and reduce domestic dollar funding costs. The experience underscored that swaps functioned as operational tools rather than directional bets on currency.

How has India’s approach evolved?
India relied largely on spot dollar purchases and sales until 2014. As intervention volumes grew, the RBI increasingly used forward market operations to sterilise spot transactions, gradually building a forward book. Since 2018, disclosures in the RBI’s monthly Bulletin provided greater transparency on forward and exchange-traded currency positions.

The RBI formally acknowledged the relevance of offshore non-deliverable markets in 2023, reflecting the growing integration between onshore and offshore rupee trading. Buy-sell swaps were first used in March 2019 to inject liquidity and offer longer-term hedging opportunities, when reserves stood near 15% of GDP. After a period of cautious use, the instrument has returned in larger size and longer tenors in recent years.

Do swap auctions signal reserve stress?
Forward short positions can sometimes unsettle overseas investors, who interpret swap usage as a way to mask reserve depletion. More experienced investors, however, assess reserve adequacy by combining spot and forward positions and comparing them with net foreign currency assets and liabilities in the international investment position.

Because swaps have defined maturities, they also allow clearer assessment of intervention outcomes. Unlike spot operations, which lack an explicit exit point, swaps can be evaluated based on interest rate and exchange rate movements between auction and maturity.

What should market participants infer?
Buy-sell swaps should be read primarily as instruments for managing domestic liquidity and facilitating risk hedging, not as signals of the RBI’s exchange-rate preference. As India’s foreign exchange reserves approach levels seen in other emerging markets, derivatives-based intervention is likely to remain an important part of the operational toolkit.

For market participants, the relevance of swap auctions lies less in interpreting policy intent and more in recognising a structured opportunity to manage currency risk when such windows open.