From UPSC perspective, the following things are important :
Prelims level: Rupee-Dollar Swap Auction
Why in the News?
The Reserve Bank of India (RBI) will conduct a $10 billion dollar-rupee swap auction on February 28, 2025, aimed at injecting durable rupee liquidity into the banking system.
This 3-year forex swap is expected to inject ₹86,000 crore into the banking system at a time when there is a liquidity deficit of ₹1.7 lakh crore in the financial sector.
What is the RBI’s Forex Swap Auction?
- Forex swap auctions are a tool used by the RBI to manage liquidity and stabilize financial markets.
- In return, the RBI will inject rupee liquidity into the banking system.
- Buy-Sell Swap: RBI buys dollars now and sells them back later (liquidity injection).
- Sell-Buy Swap: RBI sells dollars now and buys them back later (liquidity absorption).
- After 3 years, the transaction will be reversed, with the RBI selling dollars back to banks and absorbing rupee liquidity from the system.
How does it work?
- Auction Process:
- Banks bid in the swap auction by quoting the swap rate (forward premium).
- The lowest premium bids are accepted first (similar to G-sec auctions).
- Liquidity Injection:
- Banks sell US dollars to the RBI at the prevailing exchange rate.
- The RBI provides rupees in exchange, boosting liquidity in the banking system.
- Reverse Swap After Three Years:
- On March 6, 2028, the swap will be reversed.
- The RBI will return US dollars to the banks and absorb the equivalent amount of rupees.
- This allows the RBI to control liquidity over a longer period without permanently altering its forex reserves.
Significance of this move
- Reduces Borrowing Costs: More liquidity in the system lowers short-term interest rates. Bond yields and corporate borrowing costs decline, benefiting businesses and NBFCs.
- Stabilizes Foreign Exchange Markets: The rupee’s availability increases, reducing pressure on exchange rates. Lower hedging costs for companies with foreign liabilities.
- Enhances RBI’s Monetary Policy Toolkit: This approach provides a temporary boost to liquidity, while ensuring a controlled reversal in the future.
PYQ:[2015] Convertibility of rupee implies: (a) Being able to convert rupee notes into gold (b) Allowing the value of rupee to be fixed by market forces (c) Freely permitting the conversion of rupee to other currencies and vice versa (d) Developing an international market for currencies in India |
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