Inside RBI’s Dollar/Rupee Swap Auction
One wonders if at some point of time, every rich entity in the world realises that it is making more money than it knows what to do with.
The Reserve Bank of India (RBI) is facing a similar problem. Its foreign exchange reserves are plenty rich and worth $630bn at the moment (as of February 13th). So, now, the Central Bank has decided to dump some of it using an interesting tool — a buy/sell FX swap.
Yes, we understand that having more currency isn’t necessarily the only metric of wealth, otherwise, mints would be the richest entities on Earth (wait, isn’t that what Money Heist told us?). But there are times when Central Banks use their bountiful forex reserves as tools to structure a larger financial event looming in the future — like the nation’s largest IPO, for instance.
How is one connected to the other? Let’s see.
What is a Dollar-Rupee Swap?
A foreign exchange swap (aka forex swap or FX swap) means buying and selling identical amounts of one currency for another.
This means that banks shall buy Dollars from the RBI in exchange for an equivalent amount of Rupee. But they will agree to sell the same amount of Dollars at the end of the swap period which, in this particular instance, is two years.
On March 8th, the RBI held an auction for this swap and received bids worth $13.56bn (almost 3x the amount the bids called for). 86 of these bids were accepted which are valued at a total of $5.135bn (as of Tuesday’s closing rates). The cut-off premium was set at 656 paise.
FYI: The premium represents the amount that the RBI will earn from this transaction. A higher premium is a sign of excess Dollar liquidity in the system.
Why Swap?
Any article reporting this news will tell you that the Dollar-Rupee auction is a part of the RBI’s “liquidity management initiative”. But what does that mean, exactly?
Let’s start from scratch. The pandemic decimated the economy for a while. As businesses shut down and people lost their jobs, incomes took a massive hit. So, the Government intervened and released a bunch of economic stimuli mostly aimed at pumping more cash into the economy to reach people’s hands.
Two years down the line, we are not only witnessing a substantial growth rate but also an abundant amount of liquidity in the system. As a result, inflation is climbing higher than ever, catalysed even further by the booming fuel prices as an effect of the Ukraine War.
Also, another major outcome of the War has been the Rupee losing its sheen and touching new lows every day. Perhaps the RBI decided that this is also something that needs tending to.
Moreover, pursuant to the fiscal disinvestment targets set by the Government of India, we have a ₹65,000cr ($8.4bn)-sized IPO coming our way which is expected to bring major foreign inflows into the Indian markets. This would be a nice time to get rid of all those accumulated Dollars (and make room for the new ones which are inbound, thanks to the LIC IPO) that the RBI had been purchasing throughout the last two years. India bought more than $100m worth of Dollars since the beginning of the pandemic, mostly in an effort to stabilise the Rupee, much to the chagrin of the US Treasury which even branded the country as a “currency manipulator”.
So, all these factors combined hint towards a common objective for the Central Bank — to absorb the excess liquidity from the system which is now pegged at somewhere around ₹7.5Lcr ($98bn). The policy pivot towards a tighter monetary strategy has begun and the forex swap is perhaps the first of the RBI’s hawkish escapade.
What Will Be the Larger Monetary Impact?
Forex swaps, as stated, are primarily intended for liquidity management. So, their impact on the currency is largely second-degree. Having said that, given the volatility in geopolitics and consequently the global economy, it is perhaps RBI’s fundamental prerogative at the moment to keep the Rupee in check. The swap is expected to curb the Rupee volatility somewhat and curb its ongoing depreciation to some extent.
When it comes to bonds though, the forex swap may have a more pronounced impact, and it may also have come at the right time. Bond yields are already on a steep upward slope. Liquidity interventions like forex swaps basically achieve the same objective without employing traditional tools intended for the same purpose, like bond purchases, rate hikes, raising cash reserve ratios etc.
Forex swaps also reduce reliance on methods like VRRR (Variable Rate Reverse Repo) auctions to keep the liquidity in check. VRRR was tried out by the RBI last year, however unsuccessfully, because banks ended up undersubscribing to the auction as the spot market offered them instant and better returns.
The RBI, itself, however, is unlikely to benefit much from the process, except from the premiums received. Based on realisations from the 2019–2020 swaps when the cut-off premium hovered at 840–845 paisa, analysts estimate that this time, the likely gains from the swap auctions could lie somewhere around ₹8,400cr ($1bn). This would ultimately boost the dividends that the RBI pays to the Government at the end of each financial year.
(Originally published March 10th 2022 in the TRANSFIN E-O-D Newsletter)
