Central Idea

As a $5 billion forex swap between the Reserve Bank of India (RBI) and banks approaches maturity, it signifies the central bank’s strategic move to manage liquidity and mitigate inflationary pressures.

What is RBI’s Forex Swap?

Forex Tool: The Dollar–Rupee Swap is a forex tool employed by the RBI to exchange its currency with banks for another currency.
Buy/Sell Swap: It involves two variants: Dollar–Rupee Buy/Sell Swap, where the RBI buys dollars from banks in exchange for Indian Rupees, and then commits to selling the dollars back at a later date.
Sell/Buy Swap: Conversely, the RBI may sell dollars, thereby withdrawing an equivalent sum in rupees, reducing liquidity in the financial system.
Risk Mitigation: These swap operations are characterized by predetermined transaction terms, eliminating exchange rate and market risks.

USD 5 Billion Swap: The RBI initiated a USD 5.135 billion swap with banks and aims to repurchase the dollars at the lowest possible premium after a two-year tenor.
Lower Range Bids: Banks bidding at the lower end of the premium range are more likely to succeed in the auction.

Surplus Liquidity: The Indian financial system currently experiences surplus liquidity, amounting to Rs 7.5 lakh crore, necessitating measures to curb potential inflation.
Traditional Tools: Traditional methods like increasing the repo rate or Cash Reserve Ratio (CRR) can negatively impact the economy and may not lead to complete transmission of monetary policy.
Previous Toolkit: The RBI used Variable Rate Reverse Repo Auction (VRRR) but encountered under-subscription due to better yields in the cash market.
Longer-Term Strategy: As a result, the RBI opted for forex auctions as a longer-term liquidity adjustment tool.

Liquidity Reduction: The primary effect is the reduction of liquidity, which currently stands at an average of Rs 7.6 lakh crore.
Strengthening Rupee: Increased dollar inflow will strengthen the Indian Rupee, which has already appreciated against the US dollar.
Inflation Control: The RBI typically tightens liquidity when inflation risks are elevated. Factors contributing to inflation include rising oil prices due to the Russia-Ukraine conflict and foreign portfolio investors withdrawing funds from Indian stocks.

The RBI’s forex swap strategy emerges as a strategic tool to manage liquidity, stabilize the currency, and control inflationary pressures.
By reducing system liquidity and strengthening the rupee, the central bank aims to navigate the challenges posed by global events and ensure economic stability in India.