As you all know that because of the Russia-Ukraine crisis, FPI investors were leaving India (and emerging markets to safe heavens), and this was leading to depreciation in rupee.
Rupee was also under pressure due to increase in crude oil prices. This is because now oil importers are purchasing more dollars from the forex market to get the same one barrel of crude oil. Demand of dollars increasing and rupee depreciating. So, these two things were leading to rupee depreciation.
And because of rupee depreciation, imports (in rupee terms) are becoming costlier which will lead to increase in inflation in the coming time in India and this increase in inflation will further lead to rupee depreciation.
And hence RBI has done $5 billion Dollar Rupee swap. And in this swap RBI will presently remove some amount of rupee liquidity from the financial system. And when the rupee liquidity (money supply) is reduced, inflation will come down and rupee will move towards appreciation. How it will happen let me explain, the operational details may be ignored for the exam.
So, let us say today is 10th March 2022, and the dollar rupee rate is $1 = Rs. 78
So, RBI will give $5 billion to banks and banks will give Rs. 78 billion to RBI (which will reduce rupee liquidity from the Indian financial system)
And after some fixed time period (swap period),
Banks will return the same amount of dollars (5 billion) to RBI and RBI will give Rs. 78 billion +/Premium’ to banks.
In this swap, auction happens and those banks will be selected for the swap which will quote the least premium below a particular cut-off premium, say Rs. 6.56 is cut-off premium.
So, if a bank quoted premium Rs. 2.30 and another bank quoted Rs. 3.65 then the bank quoting Rs. 2.3 premium will be selected, because in this case RBI will have to give less money relatively. Now, you may say that even if RBI selected Rs. 2.3 premium, still RBI is in loss, but it all depends on what traders/market think where Rupee will go after the swap period. For example, if Rupee depreciated to $ 1 = Rs. 85 by the end of swap period then by giving Rs. 2.3 premium (above Rs. 78), still RBI is in profit.