Pedestrians walk past the Reserve Bank of India (RBI) headquarters building. (Photographer: Dhiraj Singh/Bloomberg)

RBI Buys $5 Billion Through Long Term Forex Swaps

The Reserve Bank of India, on Tuesday, successfully concluded a forex swap auction intended to ease liquidity conditions.

The central bank bought the targeted $5 billion as part of the long term Dollar/Rupee swap auction with a three-year tenor, it said in a release. In turn, Rs 34,561 crore was infused into the Indian banking system.

  • The RBI received $16.31 billion in bids for the auction
  • The cut-off for the auction was set at 776 paise
  • The cut-off was roughly 35 paise below the prevailing forward rate in the market
  • On an annualised basis, the cost of swapping dollars for three-years works out to 3.76 percent compared to Monday’s market rate of close to 3.9 percent

The auction was successful with the RBI getting bids far in excess of what it intended to purchase, said Shubhada Rao, chief economist at Yes Bank Ltd. From here on, we can expect the RBI to consider using this tool for liquidity injections along with existing options such as bond purchases under its open market operations program.

The cut-off, which was at a discount to the prevailing forward premia, was along expected lines, said a senior banker. Private and foreign banks had bid close to the cut-off while public sector banks were expecting a cut-off which was at a higher discount to the market, this banker said while speaking on condition of anonymity.

Market Impact

Markets have been divided on the impact of the RBI’s forex swap on bonds and currencies.

For the bond markets, the immediate impact will flow through the channel of easier liquidity. If banks are comfortable on liquidity, the pressure to sell down excess government bond holdings to fund credit growth will reduce. To this extent, the forex swap would be positive for bonds.

Hitendra Dave, head of global banking and markets at HSBC India, expected the swap to be slightly ‘bond positive’ as it would ease liquidity conditions, he told BloombergQuint ahead of the auction. Dave did not expect the forex swap to have much impact on the outlook for bond purchases under the open market operation programme. Such purchases were anyway unlikely in the early part of the new financial year due to relatively comfortable liquidity conditions, Dave said.

Others believe that if forex swaps become the preferred route for liquidity operations, bonds will suffer. “It is anticipated that if forex swaps were to be undertaken in larger quantum, it could replace the need of large-scale open market bond purchases. This could, however, push and steepen the sovereign bond yields depending on the duration of the swaps offered,” Jefferies said in a note ahead of the auction.

For the currency market, the swap auction is seen as being neutral.

According to Jamal Mecklai, the auction could increase the relative demand for dollars since the RBI would suck out foreign exchange which would otherwise come to the market.

“The swap should have the impact of taking dollar supply out of the market – in other words, increasing relative demand for dollars, which is the reverse of what has been happening. Of course, it could be that banks are borrowing dollars overseas to swap them into cheap rupees for domestic operations – this, then would be neutral for spot dollar/rupee,” he said ahead of the auction.

However, one clear positive from the forex swap operation is a likely drop in hedging costs. Hedging costs had already fallen ahead of the auction due to the RBI’s announcement earlier this month. Rao of Yes Bank expects this to be among the collateral benefits of the RBI’s forex swap operation.