The Reserve Bank of India's latest dollar-rupee swap auction demonstrated strong market appetite on Tuesday, with participants submitting bids worth $29.9 billion against the notified amount of $10 billion. The 3-year buy-sell swap attracted nearly three times the intended participation, highlighting significant demand for foreign exchange liquidity in the current market environment.

Auction Results and Premium Analysis

The swap auction concluded with key metrics showing increased costs compared to previous operations:

The cutoff premium of 728 paise represents a substantial increase of 127 paise from the last 3-year swap conducted in February 2025. This higher premium indicates that the RBI is purchasing dollars at a significantly increased cost compared to the previous auction, reflecting changed market dynamics and currency pressures.

Market Conditions and Currency Pressure

The elevated premium levels point to intensified pressure on the Indian rupee compared to previous periods. Market experts attribute this increase to the currency's weakened position relative to its historical trading ranges. The rupee's current vulnerability contrasts sharply with its more stable performance in earlier periods when it traded within the 85-86 range.

"Premiums have gone up because the rupee has been under that much pressure as compared to last year. This time last year, the currency was trading in the 85 to 86 handle," explained Anil Bhansali, head of treasury at Finrex Treasury Advisors.

Implications for Foreign Exchange Management

The overwhelming response to the swap auction underscores the market's need for dollar liquidity and the RBI's continued intervention in foreign exchange markets. The 3-year tenor of the swap provides medium-term stability for market participants while allowing the central bank to manage its foreign exchange reserves strategically. The higher premium reflects the true cost of dollar acquisition in current market conditions and demonstrates the RBI's commitment to maintaining adequate foreign exchange liquidity despite increased costs.

The Reserve Bank of India is expected to maintain its repo rate unchanged at 5.25% during the upcoming February monetary policy committee meeting, as economists anticipate the central bank will await new economic data before making further policy adjustments. The monetary policy committee is scheduled to convene from February 4-6, coinciding with the week following the Union budget presentation.

Inflation Trends Show Upward Pressure

Recent inflation data reveals mounting price pressures that may influence the RBI's policy stance. The following table highlights key inflation metrics:

The December consumer inflation print of 1.33% contributed to Q3 inflation averaging 0.8%, which was 20 basis points higher than the RBI's Q3 forecast of 0.6%. Economists believe the RBI will encounter similar upward pressure on its Q4 forecast of 2.9%.

Rate Cut Cycle Nears End

The central bank has implemented substantial monetary easing measures, having cumulatively reduced policy rates by 125 basis points since February 2025 to reach the current level of 5.25%. However, economists suggest this accommodative cycle may be approaching its conclusion.

"We do not foresee any further rate cuts for now, as inflation could be above 4% four quarters down," said Dhiraj Nim, economist and FX Strategist, ANZ Bank. "However, durable liquidity infusions are needed both to bring up reserve money growth and ease the prevailing upward pressure on borrowing costs."

Liquidity Management Takes Center Stage

With retail inflation projected to rise above 4% after four quarters, policy rates are widely expected to remain on hold during upcoming MPC meetings. This shift places greater emphasis on liquidity management strategies. System liquidity conditions have shown recent tightness, turning deficit in the second half of December before recovering to a tight surplus averaging ₹36,869.00 crore in January.

Economists anticipate significant open market operations to address liquidity requirements:

Soumya Kanti Ghosh, chief economic advisor at State Bank of India, expects approximately ₹2.00 lakh crore of open market operations in the remainder of FY26, with similar trends anticipated in the following fiscal year.

Market Outlook and Divergent Views

"Expectations are that another one or two tranches of OMOs and FX swaps are in the pipeline to compensate for the liquidity drain due to the FX intervention, besides seasonal leakage factors," said Radhika Rao, senior economist, DBS Bank.

However, Bank of Baroda presents a contrarian view, expecting the central bank to deliver one additional repo rate cut in February, arguing that softer inflation conditions provide room for further monetary easing. This divergent perspective highlights the ongoing debate among economists regarding the appropriate policy response to current economic conditions.