Foreign exchange swap

Foreign exchange swap

Subject: Economy

Section: External sector

Context:

On March 10, the RBI will sell USD 5 billion to banks that have bid at the lowest currency premium. The intent here is that the central bank acquires dollars from the seller, charging the lowest premium possible for the two-year tenor. Accordingly, banks that bid at the lower range of the auction are successful at the auction. Assuming a dollar rate of Rs 75, the system liquidity will shrink by Rs 37,500 crore. RBI has a two-year window to buy back these dollars.

Interestingly, apart from March 10, the far leg of March 13, 2019’s three-year USD–INR buy/sell auction falls due on March 28, 2022. This again is a USD 5 billion swap, where RBI will sell dollars to banks. With two sell auctions at play in March, nearly Rs 75,000 crore of surplus liquidity could be sucked out of the system.

Concept:

It 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. In a dollar–rupee sell/buy swap it sells USD in exchange for INR and promises to buy dollars from banks after some years.

On March 10, the RBI will sell USD 5 billion to banks that have bid at the lowest currency premium. The intent here is that the central bank acquires dollars from the seller, charging the lowest premium possible for the two-year tenor. Accordingly, banks that bid at the lower range of the auction are successful at the auction. Assuming a dollar rate of Rs 75, the system liquidity will shrink by Rs 37,500 crore. RBI has a two-year window to buy back these dollars.

Interestingly, apart from March 10, the far leg of March 13, 2019’s three-year USD–INR buy/sell auction falls due on March 28, 2022. This again is a USD 5 billion swap, where RBI will sell dollars to banks. With two sell auctions at play in March, nearly Rs 75,000 crore of surplus liquidity could be sucked out of the system.

Impact (Dollar–Rupee sell/buy swap)

• Dollar inflows from the auction and inflows of a like amount from a maturing swap towards the month end is expected to cool the volatility in the USD-INR exchange rate
• Reduce the supply of money from the economy thus, decline in inflation without changing the accommodative stance of monetary policy.
• Increase in capital inflows thus, reducing current account deficit.
• Increase credibility of government stabilization policies and thus, encourage investor and consumer confidence in the economy.
• Forex swaps help in liquidity management-longer-term liquidity adjustment tools. 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.
• Liquidity intervention through swaps indicates the RBI’s plan to use a different toolkit rather than the traditional ones, and this leaves room for the central bank to buy bonds when needed. Consequently, the strategy will contain bond yields.
• Usually, in May, RBI makes its dividend payment to the government for the previous fiscal. The surplus from these swaps could pad up the pay-outs.