Forex Swap Auction: New tool to manage liquidity by RBI
Post-NBFC crisis, the RBI has been infusing liquidity in the market using various tools. Recently,RBI announced that it has decided to conduct a USD/INR – Buy/Sell “Swap auction” of USD 5 billion for a tenor of 3 years and invited bids on March 26, 2019. Accordingly, RBI has now received bids worth USD 16.31bn. This step taken by the RBI is one of its kind. RBI has never used Currency Swaps as a tool to manage liquidity. So far RBI has used open-market operations like buying government bonds from the bank for managing the liquidity.
We aim to answer below some basics questions related to the Swap and how will this manage the liquidity concern:
What is a Forex Swap?
A foreign exchange swap, also known as a forex swap, or FX swap is a simultaneous purchase and sale of one currency for another. It is an agreement between two parties to exchange the currencies for a predetermined period and at a predetermined rate.
For eg. If two companies enter into a swap of USD 1,000 against INR for 1 year at a fwd rate of Rs 71. This means one will receive USD 1000 today by paying INR 71,000. At the end of one year, it will give back USD 1,000 and receive back Rs 71,000.
It is a simple swap of currencies at a predetermined price point for an agreed time frame.
What will RBI do in the current swap?
In the current scenario, RBI will buy US Dollars (USD) worth 5 billion from banks against Indian Rupees (INR) at an agreed rate for a tenor of 3 years in this case.
At the end of the 3 years, the banks will buy the same amount of USD from RBI at the pre-determined rate.
What is the rationale behind a 3-year tenor?
The Reserve Bank mentions that it has decided to augment its liquidity management toolkit and inject Rupee liquidity for a longer duration in order to meet the durable liquidity needs of the system. Hence a time period of 3 years has been considered reasonable for the swap.
What is the advantage of this swap?
By conducting this swap, the RBI will infuse INR worth USD 5 billion to Indian banks and will receive USD.
- This will create INR liquidity with the banks for a reasonably long duration.
- The USDs received from banks against INRs will appear in the Foreign Exchange reserve of RBI. At the same time, liability will be created in RBI’s forward liabilities for the swap.
- As a result, this transaction will also increase the forex reserves available with RBI.
- This might also help the stabilization of the USD / INR exchange rate. With the reduction of the exchange rate and the premiums, advantageous currency hedging rates for importers are likely.
- The banks generally face the outflow pressure in the month of March being year-end. This swap can help banks to ease-off the outflow pressure as they will receive liquidity from RBI.
At what rate the swap will be carried?
The RBI has received bids from various banks with their rates on 26th March 19. The banks are supposed to quote a rate that is a forward rate for the tenor of 3 years (Far leg date: 28 March 2022). However, the banks will most likely quote the rate at a price lower than the market rate to win the bid.