Sterilisation

The problem it solves

When the RBI intervenes in the currency market, it changes the amount of rupees sloshing around the banking system. If it buys dollars to stop the rupee rising too fast, it pays in freshly created rupees, flooding the system with liquidity. If it sells dollars to defend a falling rupee, it sucks rupees out. Either way, the side effect threatens to push domestic interest rates and money supply off target. Sterilisation is the central bank's way of neutralising that side effect.

How it works

The RBI offsets the liquidity impact with open-market operations (OMOs). When it sells dollars and drains rupees, it buys government bonds to pump rupees back in. When it buys dollars and injects rupees, it mops up the excess — historically using the Market Stabilisation Scheme (MSS), under which it issues short-dated government securities specifically to absorb surplus rupees during heavy capital inflows. The forex goal (managing the rupee) is thus separated from the domestic goal (keeping liquidity and rates where the RBI wants them).

A recent example

In late 2025, after selling dollars to defend the rupee — which drained rupees from banks — the RBI sterilised by injecting roughly ₹3 lakh crore of liquidity, partly through OMO bond purchases in tranches and partly via a buy/sell foreign-exchange swap. This kept domestic liquidity and short-term rates from tightening even as the currency intervention pulled in the other direction. Earlier in 2025, the central bank had also conducted large OMO purchases to address a liquidity deficit, flipping the banking system from shortage to surplus.

Why it matters

Sterilisation is why the RBI can manage the rupee *and* run independent monetary policy at the same time — it is the practical workaround to the trade-offs every open economy faces. For an investor, it explains a pattern that might otherwise look contradictory: the RBI selling dollars to support the rupee while simultaneously injecting rupee liquidity into the system. Far from a contradiction, the second move is precisely what stops the first from unintentionally tightening credit conditions for the rest of the economy.