LIQUIDITY MANAGEMENT INITIATIVE

RBI Conducts $5 billion Dollar-rupee swap

    The Reserve Bank of India (RBI) conducted a $ 5 billion dollar-rupee swap auction as part of its liquidity management initiative, leading to infusion of dollars and sucking out of the rupee from the financial system. The central bank’s move will reduce the pressure on inflation and strengthen the rupee. 

      Dollar–Rupee Swap is a forex tool whereby the central bank uses its currency to buy another currency or vice versa. In a Dollar–Rupee buy/sell swap, the central bank buys dollars (US dollars or USD) from banks in exchange for Indian Rupees (INR) and immediately gets into an opposite deal with banks promising to sell dollars at a later date. Central Banks engage in it because Forex swaps help in liquidity management. It also, in a limited way, helps in keeping the currency rates in check. A dollar–rupee buy/sell swap injects INR into the banking system while sucking out the dollars, and the reverse happens in a sell/buy swap. 

     The RBI’s planned forex swap auction went through smoothly. The central bank said it received bids worth $13.56 billion for the sell/buy auction. It accepted 86 of these bids for $5.135 billion. The cut-off premium was set at 656 paise. The first leg of the settlement will be March 10, 2022 and the second leg will be March 11, 2024. 

        The RBI would have removed close to Rs 39,000 crore ($5.135 billion) at Monday’s rupee closing rate of 76.91 per dollar. The major impact will be that liquidity which currently averages around Rs 7.6 lakh crore will shrink. The RBI normally brings down liquidity in the system when inflation threatens to rise sharply. With crude oil prices rising sharply in the wake of the Russia-Ukraine war, inflation is set to rise in the coming days. Further, foreign portfolio investors have been pulling out funds from India. They have withdrawn Rs 34,000 crore from Indian stocks in March so far, putting severe pressure on the rupee. After the swap auction on Tuesday, the rupee recovered to 76.92 from 76.97 on Monday. 

     Usually, the central bank will resort to traditional tools such as increasing the repo rate or increasing the cash reserve ratio (CRR), but this can have a negative implication on the economy. Therefore, the RBI used a different toolkit - variable rate reverse repo auction (VRRR) last year. However, the recent VRRR auctions were undersubscribed by banks, as the cash market offered instant and better yields, forcing the RBI to consider a longer-term liquidity adjustment tool such as forex auctions.  

     Market watchers observed that the swap gave companies an opportunity to purchase dollars at affordable cost to be able to service their foreign currency loans. They can also repatriate the dollars for any overseas projects. With the rupee under pressure and inflation posing a big risk to the economy, the central bank is expected to come out with more such measures to rein in inflation and prevent a big slide in the rupee. The market is also gearing up for more RBI actions in the near future.