RBI’s Maiden Dollar-Rupee Swap Auction Gets A Big Thumbs Up

Dear Aspirants, 
The Reserve Bank of India’s decision to resort to a dollar-rupee swap, instead of the traditional open-market purchase of bonds, to infuse liquidity into the economy marks a significant shift in the central bank’s liquidity management policy. Under the three-year currency swap scheme, the RBI planned to purchase $5 billion from banks in exchange for rupees. For the banks, it is a way to earn some interest out of the forex reserves lying idle in their kitty. Apart from injecting fresh liquidity into the economy, the move will have implications for the currency market even as it helps shore up the RBI’s dollar reserves. 
RBI’s OMO (Open Market Operations) purchases, however, has its own twin limitations of indirectly funding the government borrowing programme and in having an overbearing influence on the sovereign yield curve. There has been an increase in the domestic assets in the RBI’s balance sheet due to these purchases and there was a need to balance the same by increasing the foreign exchange assets. 
The RBI received 240 bids worth $16.31 billion at an average premium of Rs 7.92. The central bank accepted 89 offers totaling $5.02 billion at a cut-off premium of Rs 7.76. These premiums represent what banks are willing to pay to the central bank at the end of the swap tenor, which is fixed at three years.
The RBI received an overwhelming response to its dollar swap window on establishing the instrument as a credible liquidity tool and paving the way for more such auctions in the coming months. Banks offered $16.31 billion for the proposed swaps of up to $5 billion. The RBI accepted $5.02 billion at a cut-off premium of Rs 7.76 for three-year dollars — close to the rate at which the market was trading at.
Banks had bid to pay such that three-year MIFOR (Mumbai Interbank Forward Offer Rate) would be at 6%. The cut-off of 776 paise for three years is 6.01%. MIFOR is the rate that banks use as a benchmark for forwards. It is a mix of the London Interbank Offered Rate (LIBOR) and forward premium derived from the market. Before the auction, the three-year MIFOR was near 6.15%. The absolute premium is the amount added to the spot rate to gauge the future rate of the rupee against the dollar.
In this swap, the RBI received dollars from banks and promised to return the greenbacks at 76.62 a dollar three years down the line, irrespective of the exchange rate prevailing at that time.  The idea behind the swaps is to infuse rupee liquidity by buying dollars. So far, the central bank has been buying bonds from the secondary market to infuse liquidity. In this financial year, the RBI’s bond buying under OMOs was over Rs 2.8 trillion, a record. But this also exhausted banks’ bond holdings to pledge against future liquidity borrowing.
Effect of the dollar-rupee swap
This new tool is meant to give the central bank greater flexibility in managing banking system cash while helping soak up any potential large dollar inflows that could make the rupee rise sharply.  Overall, the dollar-rupee swap is a useful addition to the RBI’s policy toolkit as it offers the central bank a chance to directly influence both the value of the rupee and the amount of liquidity in the economy at the same time using a single tool. 
The RBI injected Rs 34,561 crore liquidity through its maiden long-term dollar-rupee swap auction. A better-than-expected market response signaled more such auctions in the future. The swaps were also successful because of heavy dollar inflows in the market. Foreign portfolio investors have brought in more than $5 billion worth of money. There are also prospects of successful overseas bidders in insolvency proceedings bringing their dollars to India. With this swaps, the RBI’s forex reserve goes up by $5 billion, effective March 28, 2019 when the first leg of the settlement will take place.