RBI Announces USD-INR Sell / Buy Swap Auction
(Update dated 29Mar2022 is available at the end of the article)
Reserve Bank of India (RBI) on February 21, 2022 announced that it would conduct a USD-INR Sell / Buy Swap Auction on March 08, 2022 amounting to USD 5 billion.
The article will explore the contours of RBI's actions in conducting Sell/Buy swaps and Buy/Sell swaps, market interpretation of RBI's swap auction and the possible impact of the latest announcement.
What is a Forex Swap?
A simple definition of a swap is an exchange, trade or barter. In the financial world, a swap is a financial transaction involving simultaneous exchange of assets (the swap) of comparable value by the counterparties.
A forex swap (FX Swap or foreign exchange swap) is a transaction between two parties involving the exchange of one currency for another on a contract date and a subsequent re-exchange of the two currencies on the contract maturity date.
In the global foreign exchange (forex) market, an FX swap is very popular as it removes the exchange rate risk. There is no exchange rate risk because both the initial and terminal exchange rates are agreed upon at the time of the contract.
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USD-INR Buy/Sell Swap versus Sell/Buy Swap?
What is the difference between a Buy/Sell Swap and Sell/Buy Swap? There are two legs to a swap transaction. First leg: On the initial date, that is, contract date, exchange of two currencies between the banks participating in the auction and the RBI. Second (reverse) leg: It is done on the maturity date, reversing the first leg as explained in Table 1 below.
Table 1: Buy/Sell Swap versus Sell/Buy Swap:
Why to do a FX Swap?
Central banks the world over too use forex swaps for a variety of reasons, including liquidity management in their domestic markets.
India's central bank, RBI, started using forex swaps as a liquidity management tool, whereby it buys US dollar from banks giving rupee funds to banks in exchange on the date when the swap was initiated. And on the maturity date, RBI will sell US dollar to banks receiving rupee funds from banks in return--thus completing the swap.
The first USD-INR Buy/Sell Swap was done by RBI in March 2019 and second USD-INR Buy/Sell Swap was done in April 2019 (details in table 2 below).
This is the first time RBI had conducted a Buy/Sell Swap as a monetary policy tool for providing liquidity to the banking system under RBI's Liquidity Management Framework introduced in August 2014.
The reason for the USD-INR Buy/Sell Swap by the Reserve Bank of India is to provide rupee liquidity to the banking system. (The terms 'buy' and 'sell' are used from RBI point of view--that is, buying USD and selling USD).
Example for USD-INR Buy/Sell Swap:
On 26Mar2019, RBI conducted a USD-INR Buy/Sell Swap for USD 5 billion for a tenure of three years. Though banks subscribed for USD 16.3 billion, RBI accepted for an amount of USD 5.02 billion only.
The first leg of the settlement was done on 28Mar2019, when RBI bought USD from banks, providing rupee funds to banks in return. The second (reverse) leg of the swap will be settled on 28Mar2022 when RBI would sell USD to banks, receiving rupee funds from banks in return thus completing the swap.
Example for USD-INR Sell/Buy Swap:
On 16Mar2020, RBI conducted a Sell/Buy Swap for USD 2 billion for a tenure of six months. Though banks subscribed for USD 4.67 billion, RBI accepted for an amount of 2.06 billion only.
The first leg of the settlement was done on 18Mar2020, when RBI sold USD to banks, getting rupee funds from banks in exchange. The second (reverse) leg of the swap was done on 18Sep2020, when RBI bought USD from banks, providing rupee funds to banks in return, thus completing the swap transaction.
Table 2: Forex Swap transactions by RBI:
What is the market interpretation?
Incidentally, Indian's biggest life insurance company, LIC of India, is coming out with an initial public offer (IPO). The offer may probably start during the second week of March 2022.
Markets are interpreting the latest RBI announcement on 21Feb2022 of Sell/Buy Swap as a tool to manage rupee and dollar liquidity in the banking system. During the LIC IPO, foreign investors are expected to bring huge amount of dollars to India as application money.
Moreover, as stated in Table 2 above, the two Buy/Sell swaps conducted by RBI in 2019 will be due for maturity (second leg of the swap) on 28Mar2022 and 25Apr2022.
Probably, RBI is expecting some turbulence in the markets against the backdrop of fears about rising interest rates globally including the US and UK; and geo-political risks emanating from the Russia-Ukraine conflict.
Summing Up
RBI has got a range of monetary policy tools to manage rupee and dollar liquidity in the banking system and forex market. It has started using the Buy/Sell and Sell/Buy swaps more in recent years.
RBI used USD-INR Buy/Sell Swaps for the first time in 2019 to provide rupee liquidity to the banking system.
It used USD-INR Sell/Buy Swaps to provide US dollar liquidity to the forex market in March 2020, when the COVID-19 pandemic hit the global markets severely.
Yesterday, it announced another USD-INR Sell/Buy swap for USD 5 billion with a view "to increasing the maturity profile of the forward book and smoothen receivables relating to forward assets."
In any market economy, there are several variables impacting the financial markets. It's a bit strange RBI has been trying to use a variety of monetary policy tools to manage liquidity in the system.
It is not clear how the tools being used by RBI are interacting with one another. For example, how its usage of forex intervention in forward market is impacting government bond yields? What is the impact of these swap auctions on the dollar-rupee exchange rate?
And what are the unintended consequences of RBI's heavy intervention in forex and bond markets through a variety of tools, like, the swap auctions, open market operations (OMO), operation twist, special market operations, conversion / switch of government securities and what not?
Today, rupee depreciated against the dollar by 30 paise and closed for the day at 74.84. Whereas, the 10-year Government bond (6.54% 2032 maturity) yield rose by six basis points (or 0.06 per cent) to 6.75 per cent.
Let us hope the actions undertaken by RBI will keep the markets on an even keel providing stability in forex, bond and stock markets.
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Update 29Mar2022
On 29Mar2022, RBI announced another USD-INR sell / buy forex swap amounting to USD 5 billion to be conducted on 26Apr2022.
The updated details of RBI's USD-INR Swaps are >
References:
Tweet 14Mar2019 - First sell / buy swap auction by RBI
26Mar2019 RBI auction result
Tweet 05Apr2019 - Second sell / buy swap auction by RBI
Apr2019 RBI auction result
RBI 16Mar2020 - first buy / sell swap auction by RBI - auction result
RBI 23Mar2020 - second buy / sell swap auction by RBI - auction result
RBI Report 26Feb2021 on Currency and Finance - FIT (flexible inflation targeting), liquidity management, USD/INR sell/buy swap auctions, liquidity management, etc.
RBI Annual Report 2018-19 dated 29Aug2019 - Box V.2 - A new armour USD/INR Sell / Buy Swap Auction for Liquidity Management Toolkit
RBI 22Aug2014 - RBI announces revised Liquidity Management Framework
Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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