This post talks about use of Liquidity Adjustment Facility by the central bank to “sterlise” its purchase of forex exchange
These operations help RBI to manage day-to-day liquidity by absorbing or supplying funds by selling/buying securities through repo/reverse repo auctions. Market participants can make use of this facility as per their liquidity needs.
LAF operations require adequate stock of government securities with the Reserve Bank. The costs involved in such operations are included in the balance sheet of the Reserve Bank. LAF has not been used to sterilize liquidity of “durable nature”. Hence, they have been used only for limited periods along with other instruments.