All About Rupee-Dollar Swap of RBI

Recently, RBI has made a surprise decision to allow for a Rupee-Dollar swap from banks to boost liquidity into the banking system.

What Is Rupee-Dollar Swap ?

Generally, to infuse liquidity into the banking system RBI conducts Open Market Operations (OMOs) where it buys government bonds from the banks through repurchase (repo) window.
Here, the RBI will hold the bonds with itself for a short time period.
In the new buy/sell swap (b/s), which RBI is trying for the first time, instead of bonds RBI will purchase dollars from the banks with the rupee.
It keeps the dollars with it for three years and after three years returns these dollars for a ‘forward premium’.
This forward premium will be determined through an auction.
In its decision, RBI has announced the swap for $5 billion (Rs. 35000 crores).

Why The Need For A Swap ?

RBI might have felt that more OMOs will leave the banks with insufficient bond holdings for repo operations and their regulatory commitments.
But, evidence suggests otherwise. Banks exceed the Statutory Liquidity Ratio of 19.5% of bond holdings to 27.9%.
There are three other reasons for the move by the RBI.
Reason 1: Large purchase of government bonds through OMOs by the RBI has the potential to distort the yield curves which are benchmarks for interest rates for loans of various maturities. Also, OMOs will make the borrowing costs of government artificially low that might affect fiscal discipline.
Reason 2: By supplying large amount forwards, RBI might be looking to pull down the premium of forwards which have already fallen down by one-third since the RBI’s announcement of the swap. This incentives the foreign currency borrowers to hedge against any risk of rupee downfall. Also, a low premium will attract more foreign investments into the country. It thus appears that the RBI wants a stable flow of dollars in the medium to the long run with low risks and ensure that there is no capital starvation in the economy.
Reason 3: The final reason might be RBI’s concern over appreciating rupee. Here, the assumption is that RBI by buying dollars in one shot will arrest the appreciation of rupee. But, evidence shows otherwise as rupee appreciated since the announcement by the RBI. It is partly due to banks bringing in offshore dollars to the auction which they are allowed to.

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