• The Reserve Bank of India conducted the Dollar-Rupee (USD/INR) swap auction.
  • This is being done in order to increase rupee liquidity in the market.
  • The size of this auction is $5 billion, and the tenor is three years.

Tell us more about it

  • The RBI has different tools through which it injects liquidity into financial markets.
  • Adjusting repo rates and purchasing bonds by conducting open market operations (OMO) are a couple of tools which the RBI uses regularly either to increase or decrease the currency supply in the market.
  • The recently announced ‘swap auction’ which will be conducted today is one such tool.
  • This is being done to increase the supply of rupees in the market.
  • Technically, this activity is being termed as a USD/INR Buy/Sell Swap Auction.
  • Through this auction, the RBI will buy US dollars from banks totalling to $5 billion.
  • In turn the RBI will pay rupees to the participating banks at the current spot rate.
  • At an average spot rate of 70 per dollar, the RBI will able to infuse about ₹35,000 crore into the system through this auction process.
  • Simultaneously, the banks will agree to buy-back the same amount of dollars from the RBI after three years — the tenor of this auction.
  • The participating banks have to bid in the auction by quoting a forward premium in terms of paisa that they will pay to buy back the dollars.
  • For example, if the spot exchange rate is 70 to a dollar, say Bank A quotes a premium of 150 paisa and bids for $25 million. So, the bank will get ₹175 crore ($25 million multiplied by the exchange rate of 70).
  • After three years, the bank has to pay back approximately ₹179 crore ($25 million multiplied by the exchange rate of 71.5) to the RBI to buy back $25 million.

Why is it important?

  • Indian financial markets have been undergoing liquidity problems since the IL&FS crisis emerged last year.
  • The market is likely to see even tighter liquidity from a rush to pay advance tax as the financial year end is less than a week away.
  • In addition to this, the demand for rupees is expected to spike in the coming weeks as a result of a huge spending towards the upcoming general elections that starts next month.
  • So, the timing of the RBI’s auction, at the end of the financial year seems to have taken into account these factors.
  • For the RBI, the auction will help boost its forex reserves by another $5 billion.
  • The reserves as on March 15, is $405.6 billion.
  • The forex reserve is one tool which the RBI uses to intervene in the currency market at times of abnormal volatility.
  • From a common man’s perspective, this auction is expected to improve fund availability with the banks.
  • Whether this will moderate borrowing costs in the short term though needs to be seen.
  • But only the Category-I banks are allowed to participate in the auction, not all players in the financial services sector will be able to get the benefits or lower their rates.
  • Also, if the participating banks decide not to loosen up on credit to specific segments such as NBFCs, the credit crunch for them is likely to continue.

  • From a business perspective, the hedge cost for the importers are likely to come down as increased rupee liquidity is likely to bring down the forward rates.
  • Indeed, the forward premiums have been falling ever since the RBI announced this auction on March 13.
  • The RBI is deploying a new weapon to enhance market liquidity. Whether it will hit or miss the target, will be known only over time.