How RBI could tackle a liquidity deluge triggered by dollar deposits
A special Reserve Bank of India (RBI) scheme allowing banks to raise long-tenor foreign currency deposits attracted a record $127.23 billion in inflows, with cumulative forex inflows under the broader window crossing $136 billion.
Because banks swap these dollar deposits with the RBI for rupees, the scheme has injected a large volume of rupee liquidity into the banking system, pushing the systemic liquidity surplus to a record high of about ₹9.70 trillion.
Such a large surplus risks easing short-term interest rates below the policy corridor and building inflationary pressure if left unaddressed.
The RBI is expected to deploy a mix of liquidity-absorption tools — variable rate reverse repo (VRRR) auctions of longer tenor, FX swaps, the Market Stabilisation Scheme (MSS), a hike in the Cash Reserve Ratio (CRR), and outright open-market sale of government bonds — to mop up the excess without destabilising currency or bond markets.
FCNR(B) Deposits and the RBI Dollar Swap Window
Foreign Currency Non-Resident (Bank) deposits, or FCNR(B), are term deposits that Non-Resident Indians can hold in foreign currency (commonly USD) with Indian banks; principal and interest are both denominated and repaid in that foreign currency, insulating the depositor from rupee exchange-rate risk. To attract fresh dollar inflows and shore up forex reserves, the RBI has periodically opened special swap windows under which banks mobilising fresh FCNR(B) deposits of a specified tenor can swap the dollars with the RBI, often with incentives like exemption from CRR/SLR requirements on the incremental deposits and RBI absorbing part of the hedging cost.
Key Details
- The 2026 window (RBI circular dated June 2026) applied to fresh or renewed FCNR(B) deposits of three-to-five-year tenor booked between June and September 2026, exempted the mobilised deposits from CRR and SLR, and removed the interest-rate ceiling on such deposits.
- A similar swap window was first used in 2013 under Governor Raghuram Rajan to defend the rupee during the "taper tantrum," attracting roughly $34 billion at the time.
- Interest on FCNR(B) deposits is exempt from Indian income tax under Section 10(15)(iv)(fa) of the Income Tax Act, 1961.
The 2026 swap window drew a far larger $127.23 billion, both due to the CRR/SLR exemption sweetener and elevated global dollar rates, and it is this swap mechanism (RBI buying dollars and releasing rupees) that generated the current systemic rupee liquidity glut.
Liquidity Management Tools: VRRR, MSS, CRR and OMOs
When banking-system liquidity is in surplus, the RBI uses several instruments, of differing tenor and market impact, to absorb (sterilise) the excess rupee liquidity and keep short-term rates aligned with the policy repo rate.
Key Details
- Variable Rate Reverse Repo (VRRR): An auction-based tool (distinct from the fixed overnight reverse repo) where banks bid to park funds with the RBI for a fixed multi-day tenor (commonly 7 or 14 days) at a market-discovered rate; used for short-to-medium-term liquidity absorption.
- Market Stabilisation Scheme (MSS): Introduced in 2004 to sterilise the rupee liquidity created by RBI's forex-market interventions; under MSS, the Government issues additional Treasury Bills/dated securities (beyond its normal borrowing) whose proceeds are impounded in a separate RBI account, permanently withdrawing that liquidity until the securities mature.
- Cash Reserve Ratio (CRR): A statutory, non-remunerated percentage of a bank's Net Demand and Time Liabilities that must be kept with the RBI; a CRR hike is a blunter, more durable liquidity-absorption tool than VRRR. CRR stood at 3% as of 2026 (effective November 2025) after successive cuts.
- Open Market Operations (OMO) — bond sales: RBI selling government securities in the secondary market to permanently drain rupee liquidity, as opposed to the temporary absorption via repo/reverse-repo instruments.
Facing a record ₹9.70 trillion surplus generated largely by the FCNR(B) swap inflows, the RBI is expected to combine short-tenor VRRR auctions (to manage day-to-day surplus) with more durable tools like MSS, CRR adjustment, or OMO bond sales if the surplus proves persistent rather than transient.
FX Swaps as a Dual-Purpose Monetary Tool
An FX (foreign exchange) swap is a transaction in which the RBI simultaneously buys (or sells) dollars for rupees in the spot market and agrees to reverse the transaction (sell or buy back dollars) at a future date at a pre-agreed rate. It serves both as a forex-reserve/exchange-rate management tool and, incidentally, as a liquidity-management tool, since the rupee leg injects or absorbs liquidity depending on the swap's direction.
Key Details
- A buy/sell dollar swap (RBI buys dollars now, sells later) injects rupee liquidity upfront; a sell/buy swap absorbs rupee liquidity upfront and injects dollars.
- The RBI has previously used sell/buy dollar swaps specifically to drain excess rupee liquidity while simultaneously supporting the currency, making it attractive when both liquidity absorption and rupee support are needed together.
Because the current liquidity surplus stems from dollar-swap deposits, further FX swaps (in the reverse direction) are seen as a natural, twin-purpose tool for the RBI to both mop up liquidity and manage the rupee.
- Total inflows into the RBI's special dollar deposit (FCNR-B swap) scheme: $127.23 billion; broader forex inflow tally: over $136 billion (as of end-August 2026).
- Systemic banking liquidity surplus reached a record ₹9.70 trillion (roughly $102.7 billion) following the scheme.
- Current CRR: 3% (effective since November 2025); current repo rate: 5.25% (as of the RBI MPC's June 2026 meeting).
- MSS was introduced in 2004; VRRR auctions are typically conducted for 7-day or 14-day tenors.
- The 2026 FCNR(B) swap window covered deposits of 3-to-5-year tenor booked between June and September 2026, with CRR/SLR exemption and a mandatory one-year lock-in.