The Reserve Bank of India (RBI) has long played a pivotal role in managing the Indian economy, especially during periods of financial turbulence. Whether it’s intervening in the bond market to manage yields or stepping into the foreign exchange (forex) market to stabilize the rupee, the central bank often emerges as the biggest trader in town.
During the COVID-19 pandemic in 2020–21, the RBI undertook unprecedented measures. It purchased a massive ₹3.3 trillion worth of government bonds to inject liquidity and stimulate demand. Simultaneously, it bought $68 billion from the forex market, significantly boosting India’s foreign exchange reserves.
That period marked a clear instance of the central bank taking center stage in financial markets. But here’s the twist: It appears the RBI is back at it—and this time, its involvement could exceed even the pandemic-era intervention levels.
📊 RBI’s Record-Breaking Bond Purchases in FY 2025–26
Let’s look at the numbers. In just the first two months of FY26, the RBI has already purchased a staggering ₹2.4 trillion in government bonds. Analysts, including those at Emkay Global Financial Services, estimate that the total bond purchases this fiscal year could touch ₹4.4 trillion.
If that forecast holds, the RBI would surpass its own record from the pandemic era. This raises a critical question: Why is the central bank deploying such large-scale liquidity operations when we’re not even in a crisis?
💡 The Real Driver: Liquidity Management
The answer lies in liquidity management.
Every time the RBI sells dollars in the forex market to stabilize the rupee, it sucks rupees out of the system, causing a liquidity deficit. To compensate for this drain, the RBI has to inject rupees back into the banking system—and the most effective way to do that is by buying government bonds.
This liquidity support is especially crucial at a time when India is aiming to kick-start an easing interest rate cycle to promote economic growth. Lower interest rates require a surplus liquidity environment to avoid a rise in short-term rates and bond yields. Hence, the central bank’s aggressive bond-buying spree.
🌍 The Vicious Loop: Forex Market Interventions and Bond Purchases
But here’s where it gets complicated. Suppressing bond yields has a downside.
Foreign investors look at the interest rate differential between Indian bonds and U.S. Treasuries. As of now, that differential is near a decade-low, and with U.S. bond yields rising due to fiscal deficit worries there, the appeal of Indian assets is declining.
A narrowing differential can trigger capital outflows. When foreign investors sell, they convert their rupee holdings into dollars, leading to downward pressure on the rupee. To counter this, the RBI is forced to sell dollars from its reserves—sucking liquidity out again and undoing the effect of bond purchases.
This creates a vicious cycle:
- RBI buys bonds → Injects rupees
- RBI sells dollars to stabilize rupee → Sucks rupees
- RBI needs to buy more bonds → Repeats the cycle
This loop has made it almost impossible for the RBI to exit the market gracefully. It must maintain balance in both markets simultaneously, or risk causing disruptions in growth, inflation, capital flows, or the current account.
📈 Data vs. Reality: The Scale of RBI’s Operations
Charts tracking the RBI’s market actions often understate its role, as they typically show only end-of-period data. The real picture involves multiple entries and exits—on both the buying and selling sides of the bond and forex markets.
Since the pandemic, the RBI’s trading volume has grown substantially, driven by both domestic needs and global uncertainty.
🔍 A Double-Edged Sword for Policy
On one hand, the RBI’s dual intervention approach ensures macro stability, curbs volatility, and supports economic recovery. On the other hand, too much intervention distorts market signals, delays the transmission of monetary policy, and undermines the central bank’s long-term goal of creating free, efficient, and liquid markets.
There’s also the credibility question. A central bank that intervenes too frequently might face skepticism over its inflation-targeting or monetary policy independence.
🔮 What Lies Ahead?
Unless capital inflows pick up or U.S. yields stabilize, the RBI will likely remain entangled in this liquidity conundrum. The only sustainable way out may involve a combination of:
- Gradual rupee depreciation, to allow markets to find a natural level.
- Increased fiscal coordination, so that monetary policy doesn’t carry the full burden of economic recovery.
- Strengthening capital markets, to reduce dependence on foreign portfolio flows.
🧠 Final Thoughts: Should the RBI Let Go?
If India aspires for deep and efficient capital markets, where prices reflect real supply-demand fundamentals, the RBI may need to loosen its grip—at least gradually.
For now, however, it seems clear: The RBI is back as the biggest trader in town. The balancing act it is performing is remarkable, but it cannot go on forever without consequences.
📌 Bonus Insight: Why It Matters for Investors
- Bond investors should watch RBI actions closely, as they significantly impact yields.
- Currency traders need to understand intervention patterns to manage risk better.
- Equity investors can interpret RBI actions as a signal of liquidity trends, impacting overall market sentiment.