RBI’s Dollar-Rupee Swap Auction

Why in news?

• The Reserve Bank of India (RBI) on 9^th March 2022 conducted a USD 5 billion dollar-rupee swap auction as part of its liquidity management initiative, leading to infusion of dollars and sucking out of the rupee from the financial system.
• The central bank’s move will reduce the pressure on inflation and strengthen the rupee.

What is a swap auction?

• Under the swap, a bank would sell US dollars to the RBI.
• It will simultaneously agree to buy the same amount of US dollars at the end of the swap period.
  • The swap transaction is materially different from OMOs (open market operations).
  • OMOs refer to a central bank's buying and selling of government securities in the 'open market'.
• On the other hand, in swap transaction, only authorised dealers, mainly banks, will be allowed to deposit US dollars in exchange for rupees.
• This comes with an agreement to reverse the transaction at a fixed exchange rate at the end of 3 years.
• The final exchange rate will be decided by an auction where banks will bid on the forward premium they are willing to pay.
• Under the swap auction, minimum bid size would be USD 25 million and in multiples of USD 1 million thereafter.

Why does RBI engage in it?

• Forex swaps help in liquidity management.
• It also, in a limited way, helps in keeping the currency rates in check.
• 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.
• Usually, the central bank will resort to traditional tools such as increasing the repo rate or increasing the cash reserve ratio (CRR) to curb inflation, but this can have a negative implication on the economy.

What’s the impact of the swap?

• Check inflation
  • The RBI would have removed close to Rs 39,000 crore at Monday’s rupee closing rate of 76.91 per dollar. The major impact will be that liquidity which currently averages around Rs 7.6 lakh crore will shrink.
  • The RBI normally brings down liquidity in the system when inflation threatens to rise sharply. With crude oil prices rising sharply in the wake of the Russia-Ukraine war, inflation is set to rise in the coming days.
• Strengthen rupee:
  • Further, foreign portfolio investors have been pulling out funds from India. They have withdrawn Rs 34,000 crore from Indian stocks in March so far, putting severe pressure on the rupee. After the swap auction on Tuesday, the rupee recovered to 76.92 from 76.97.

Add ons:

• The swap auction can be done in the reverse way also when there is shortage of liquidity in the system.
• The RBI then buys dollars from the market and releases an equivalent amount in the rupees.

PRACTICE QUESTION:

Which of the following statements is/are correct regarding ‘RBI's Foreign Exchange Swap’?

1. It helps in reducing inflation in the economy

2. It involves buying and selling of government securities in the open market

Select the correct answer using the code given below:

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither

Answer