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RBI’s Dollar -Rupee Swap Auction

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Reserve Bank of India has announced that it will conduct an 18 months  US Dollar and Indian Rupee sell/buy swap auction of $5 billion on 26 April 2022.  This is the second sell/buy swap auction of $ 5 billion by the RB within two  months . It conducted  a similar  two year sell/buy swap auction on 8 March 2022.

The Dollar -Rupee swap is basically a foreign exchange tool of the RBI to influence liquidity in the market and also as a tool to stabilize the currency rates of Indian rupee against US dollars  in a limited way .

 Why does RBI conduct such operations and what is the meaning of Dollar-Rupee swap auction. 

What is a Rupee- Dollar Swap 

Swap means exchange . So here the word Rupee dollars swap means exchange of Indian Rupees with US Dollars .  The Dollar Rupee  swap involves two  contracts . For eg if it is a sell/buy contract then RBI will sell dollars to the banks and the bank will pay equivalent amount of Indian rupees to the RBI . Another reverse  contract is also signed between the Banks and the RBI where the RBI promises to buy back the dollars from the banks at a future date . This future date is mentioned in the contract and is also called the end of the swap period.

If it is a Buy /sell contract then first RBI will buy dollars from the banks and then promises the banks that it will  sell back the dollars to the banks at  a future date .

So essentially the swap contracts involve two contracts which are signed simultaneously between RBI and Banks .

 How is the exchange rate decided 

Exchange rate means the rate at which RBI sells dollars to the banks and  vice -versa.

The banks which are willing to participate in the RBI’S Dollar Rupee sell/buy  swap have to bid for the Dollar .  It means the RBI will auction the dollars and the Banks will have to quote a price .

 RBI uses  FBIL(Financial Benchmarks India Private Ltd) Reference Rate  of the auction date to fix the base price  The participating banks  will have to quote a premium in paisa terms up to two decimal places on which they are willing to receive from RBI during the time period of the swap contract .  Banks quote a  premium during the auction and the bank which has quoted the lowest premium will get the contract .

What happens after the auction is completed 

The successful bidder banks will buy the dollares from the RBI at the FBIL reference rate and RBI will deduct the equivalent rupee amount from the bank's current account held with RBI and RBI will transfer the dollars to the bank’s nostro account .

Now we know that there are two contracts in the Swap deal .  After a certain time period RBI will transfer the rupee amount  with the premium to the bank account and the banks will transfer the dollar amount to the RBI . 

Why does RBI conducts  Dollar -Rupee  Swap 

It is a foregin exchange(forex) tool of the RBI to manage liquidity in the market .

How does  it work? Suppose RBI feels that there is excess liquidity in the market .

In simple terms it means that  there is enough money in the market which can create demands for goods and services. If  the goods and services available in the market is less than the demand then it will create a rise in prices of goods and services or inflation. 

To control inflation ,RBI has many tools like increasing the Repo rate or increasing the Cash Reserve Ratio(CRR) or Statutory Liquidity Ratio(SLR).

But RBI can use another tool like the Dollar -Rupee Swap .

RBI comes out with sell/buy Dollar- Rupee swap . Suppose it sells $100 dollars and the FBIL  reference rate is Rs 80 per dollar on that day . Suppose SBI buys the $100 dollars then it will have to pay  Rs. 100x80= 8000 rupees to the RBI . It means the ability of the SBI to lend in the market will be reduced by Rs 8000 . Or in other words Rs 8000 worth of liquidity was sucked from the market  by the RBI .  This will help in reducing inflation in the economy .

Just the opposite will happen if RBI conducts a buy/sell  Dollar-Rupee Swap .  In this case banks will sell dollars to the RBI and the Banks will receive Rupee from the RBI.  The banks will now have excess liquidity and they will lend it in the market.  This will increase liquidity in the market . It is called a liquidity injection.

What is the benefit for the banks 

The banks will get dollars from RBI for a certain time period . The Bank can use these dollars to repay its foreign debts.

The banks which will have surplus dollars can provide cheaper loans to Indian companies so that they can buy oils and other commodities from the International markets .

Why is the RBI conducting the Dollar-Rupee swap auction in April 

According to an estimate the excess liquidity in the system is around Rs 8 trillion .  Also the government of India is expected to give go ahead to the Initial Public offering (IPO) of Life Insurance Corporation(LIC)  in Mid-April . The LIC issue is expected to attract some Rs 60,000-Rs 65,000 crore as subscriptions with a big proportion coming from foreign portfolio investors.  This will further increase the liquidity in the market. 

The sell/buy Dollar-Rupee swap auction of the RBI on 26 April 2022 is expected to mop up excess liquidity from the system .

How will the RBI move will affect the valuation of Rupee and exchange rates 

The Dollar-Rupee swap is mainly a forex tool to influence liquidity in the market by the RBI .  But it is going to affect other sectors of the economy, especially the valuation of  the Rupee for a short term .

When RBI sells the dollars in the market to the banks , it leads to an increase in the supply of dollars in the market  and correspondingly  decrease in the supply of Rupee in the market .  According to economic theory if the demand of the Rupee is more than its supply then the value of Rupee against Dollars will increase.  This is likely to reduce volatility in the exchange rate of Rupees as compared to US Dollars  

However, the impact on the exchange rate of Rupee is expected to be limited.

There are many factors which determine the  exchange rate of Rupees,like trade deficit , flight of capital from India , volatility in oil prices etc. 

The continuous increase in the price of oils and the commodity prices due to the Russia-Ukraine war will eventually weaken the Rupee as compared to dollars . RBI can at best hope that the value of Indian Rupee does not depreciate too much and it becomes at least stable due to its action of Dollar-Rupee swap auction .

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