Examine how instruments beyond the policy repo rate — such as forex swaps and hedging cost absorption — help the RBI manage exchange rate stability and capital flows.

Under the Flexible Inflation Targeting framework (RBI Act, 1934, Sections 45ZA–45ZB), the repo rate is legally anchored to the 4% CPI target [1], making it a blunt instrument against external shocks. The RBI's August 2026 pause at 5.25% with a neutral stance [2] therefore rested on a parallel forex-and-liquidity toolkit.

Why the repo rate alone is inadequate

• The rate is committed to domestic price stability; using it to defend the rupee would conflict with the statutory mandate [1].
• With inflation pressure concentrated in food and fuel and growth to be protected, a defensive hike would have choked demand while leaving imported, crude-driven inflation untouched.

Forex swaps and market operations — exchange rate stability

• Dollar-rupee swaps inject rupee liquidity while absorbing dollars (or vice versa), smoothing volatility without permanently depleting reserves — a managed float, not a fixed peg.
• They allow the RBI to defend the currency while keeping forex reserves adequate, published weekly in the Weekly Statistical Supplement [3].
• Signalling effect: visible capacity to intervene deters one-way speculative bets against the rupee.

Hedging cost absorption — steering capital flows

• The special concessional swap window, operational from June 8, 2026, covers fresh FCNR(B) deposits, overseas foreign currency borrowings and ECBs [4].
• By absorbing the hedging cost itself, the RBI made dollar funding cheaper for banks, mobilising about US$40.8 billion by July 31, 2026 [5].
• Crucially, it substitutes volatile portfolio flows with contractual 3–5 year deposits, improving the quality, not merely the quantity, of inflows.

Limitations

• Costs migrate to the RBI's balance sheet; repayment risk is deferred to maturity, and the underlying current account pressure from crude remains.

These instruments let the RBI pursue price stability and external stability simultaneously, resolving the "impossible trinity" through calibrated segregation of tools. Going forward, pairing them with export diversification and energy-import moderation would convert episodic firefighting into durable external resilience.