Rupee-Dollar swap: RBI’s new tool

The country’s foreign exchange reserves surged by a whopping $5.23 billion to $411.90 billion in the week ending March 29, as per data released by the Reserve Bank of India. The entire increase of $5.23 billion was in foreign currency assets, which is a major component of the overall reserves. The increase in forex reserves was mainly due to a novel rupee-dollar swap conducted by RBI on March 26, which received bids worth $16.3 billion against the target amount of $5 billion. Encouraged by the overwhelming response to the rupee-dollar swap, the RBI has announced another round of swap auction on April 23.

Foreign currency assets, expressed in dollars, are impacted by fluctuations in the exchange rates of non-US currencies like the euro, pound and the yen held in the reserves. There were many reasons why RBI ventured to go in for the rupee-dollar swap auction.

One of the reasons could have been RBI’s discomfort over the relentless FII inflows in recent months, leading to a sharp appreciation of the rupee from Rs 74.35 to the dollar on October 10 last year to Rs 68.57 on March 21 this year — an increase of nearly 8% in a matter of five months!

In such a scenario, traditionally, RBI would have intervened in the forex market and bought dollars aggressively to arrest rupee appreciation. The RBI must have also felt that exporters were losing export competitiveness due to the rupee appreciation. Instead of directly intervening in the spot market to prop the rupee, the RBI went in for a novel dollar swap with a three-year maturity.

Under the swap, RBI would buy the excess dollars from banks now and sell it to them after three years at a premium discovered through auction. Armed with the new tool, RBI sucked out $5 billion and injected Rs 35,000 crore into the economy. This would influence both the forex and money markets simultaneously.

Based on the bids received from banks, the cut-off premium was fixed at Rs 7.76. Just to understand how the swap mechanism works, RBI would buy greenbacks from banks at Rs 68.86, that is, the closing price on March 26, 2019, and sell it to them at Rs 76.62 after three years -- at a premium of 776 paisa.

This was 13 basis points less than the three-year MIFOR rate (Mumbai Interbank Forwards Rate) — a win-win situation for the high street banks as well since they could offload excess dollars and deploy the funds for lending and earn a higher rate of interest than that inherent in the forward premium.

The RBI achieved many objectives with the swap auction. It has infused liquidity in the system without resorting to open market operations (OMO), where it would have to buy securities from banks. Since RBI had already purchased securities worth Rs 3 lakh crore during fiscal 2018-19, it must have felt that depending too much on OMO as a tool to increase money supply in the economy was not prudent.

In addition, it would also depress interest rates. The swap has also helped in reducing the forward premium of the dollar. The biggest benefit is that the swap added a new tool of monetary policy to RBI’s arsenal for injecting durable liquidity in the economy.

FCNR(B) of 2013

The only other time the RBI had gone in for a swap mechanism was in 2013 when, between September and November 2013, it announced a special scheme under FCNR (Banks) scheme, intended to encourage banks to attract sizeable dollar inflows in the form of FCNR(B) deposits.

Banks were encouraged to get their NRI clients to deposit surplus dollars at a fixed interest rate, with the RBI protecting the banks from the exchange rate risk. Banks were allowed to swap the dollars so mobilized from their NRI customers with the RBI for a period of three years and pay interest of 3.5% per annum.

Banks raised nearly $26 billion from the FCNR deposits and sold them to RBI and received the rupee equivalent under the swap arrangement. However, this swap was for a different reason and was necessitated due to the rupee falling to an all-time low in August 2013 to Rs 68.85 against the dollar after the US Federal Reserve announced its tapering programme, leading to flight of dollars and depreciation of the rupee.

The RBI has announced a second swap on April 23 to inject Rs 35,000 crore into the economy by buying $5 billion. Incidentally, the National Company Law Appellate Tribunal (NCLAT) recently directed global steel major ArcelorMittal to deposit the bid amount of Rs 42,000 crore or $6 billion in greenbacks to acquire Essar Steel during the next hearing on the same date — April 23.

Is it just a coincidence or is RBI trying to pre-empt and suck out the oversupply of greenbacks so that the rupee does not appreciate further?

(The writer is with Manipal Academy of Banking, Bengaluru)