RBI’s USD-INR SWAP AUCTION: ECONOMY

RBI’s USD-INR SWAP AUCTION: ECONOMY

NEWS: RBI to conduct USD-INR swap auction of $10 bn for 3 years’ tenor to inject liquidity 

 

WHAT’S IN THE NEWS?

The Reserve Bank of India (RBI) has announced a USD-INR Buy/Sell swap auction worth $10 billion for a tenor of three years on February 28, 2025.The move aims to inject long-term Rupee liquidity, stabilize the currency, and mitigate volatility caused by foreign fund outflows.This will be the second swap auction in a month, following a $5.1 billion six-month swap conducted on January 31, 2025.

 

Understanding Rupee & Dollar Swap Auctions

1. What is a Swap Auction?

  • A monetary policy tool used by the RBI to manage liquidity and stabilize currency volatility.
  • It involves banks selling US dollars to the RBI in exchange for rupees, with an agreement to buy back the dollars at a future date.

2. How Does It Work?

  • Buy Phase: Banks sell USD to the RBI and receive INR in return.
  • Sell Phase: After a fixed period, banks buy back USD from RBI at a pre-determined exchange rate.

 

Key Features of the Swap Auction

1. Tenor (Duration)

  • Can be short-term (e.g., 6 months) or long-term (e.g., 3+ years).

2. Liquidity Management

  • Helps inject or absorb rupee liquidity in the banking system.
  • Ensures stability in the financial markets during times of liquidity shortages or excess.

3. Forex Reserve Utilization

  • RBI uses its foreign exchange reserves to regulate currency flows.
  • Helps balance rupee supply and demand in forex markets.

4. Impact on Exchange Rate Stability

  • Prevents sharp rupee depreciation by stabilizing currency fluctuations.
  • Strengthens market confidence and mitigates volatility due to capital outflows.

 

Impact on the Indian Economy

1. Enhancing Banking Liquidity

  • Injects funds into the system, reducing liquidity deficits in the banking sector.
  • Ensures adequate credit availability for businesses and consumers.

2. Strengthening Monetary Policy Transmission

  • Aligns interest rates with RBI’s monetary policy stance.
  • Helps in better control of inflation and credit growth.

3. Supporting Economic Growth

  • Additional liquidity boosts bank lending to businesses, industries, and infrastructure projects.
  • Encourages investment and economic expansion.

4. Strengthening the Rupee

  • Reduces depreciation pressure by stabilizing forex reserves.
  • Improves investor confidence in the Indian economy.

5. Controlling Inflation Risks

  • Adds liquidity without causing inflationary pressure, as funds are backed by forex reserves.

 

Details of the RBI Swap Auction Mechanism

1. Nature of the Swap

  • It is a simple buy/sell foreign exchange swap conducted by the RBI.
  • Banks sell US dollars to RBI and agree to buy them back at the end of the swap period.

2. Auction Mechanism

  • Conducted through a multiple-price-based auction.
  • Successful bids get accepted at their respective quoted premiums.

3. Bidding Process

  • Bids must be placed in premium terms, expressed in paisa up to two decimal places.
  • Auction cut-off is determined based on the highest accepted premium.

4. Minimum Bid Size

  • $10 million, with increments in multiples of $1 million thereafter.

5. Eligible Participants

  • Only Authorised Dealers (ADs) – Category-1 banks are allowed to participate.

6. Settlement Process

  • First Leg:
  • Banks sell US dollars to RBI at the FBIL Reference Rate on auction date.
  • The settlement happens on a spot basis, with banks delivering USD into RBI’s nostro account.
  • Reverse Leg:
  • After the swap period ends, rupee funds must be returned to the RBI.
  • Banks receive back their US dollars, along with the swap premium.

 

Objectives of the Swap Auction

1. Currency Stabilization

  • Helps stabilize the Rupee by providing immediate liquidity support.
  • Mitigates the impact of foreign fund outflows on exchange rates.

2. Managing Exchange Rate Volatility

  • Strengthens market confidence by reducing excessive fluctuations in the rupee-dollar exchange rate.
  • Prevents sharp depreciation of the rupee during volatile market conditions.

3. Controlling Inflationary Pressures

  • Absorbs excess liquidity in the economy, reducing inflation risks.
  • Strengthens forex reserves, enhancing India’s financial stability.

 

Understanding the Currency Swap Auction Mechanism

1. What is a Currency Swap?

  • A financial agreement between two parties to exchange cash flows or liabilities.
  • Swaps generally involve notional principal amounts such as bonds, loans, or forex reserves.

2. Process of a Swap Auction

  • Banks bid for the opportunity to exchange Indian Rupees for US Dollars at a pre-determined exchange rate.
  • RBI conducts an auction where banks submit bids to secure the swap at the best rate.
  • Currency swaps are over-the-counter (OTC) instruments, meaning they are not traded on centralized exchanges.

3. Objectives of Currency Swaps

  • Liquidity Management:
  • Injects or absorbs liquidity in the forex market by adjusting access to foreign currency.
  • Hedging Currency Risks:
  • Allows banks and businesses to protect themselves against exchange rate fluctuations.

 

Limitations of Currency Swap Auctions

1. Counterparty Risk

  • There is always a risk that one party defaults on their obligations.
  • RBI must ensure credible participants in swap auctions.

2. Complexity of Execution

  • Not all financial institutions can effectively use swap instruments.
  • Requires sophisticated risk management strategies.

3. High Associated Costs

  • Swap agreements involve:
  • Swap fees
  • Hedging costs
  • Operational expenses
  • These can be significant, depending on the market conditions.

4. Limited Liquidity for Swaps

  • Once a swap agreement is entered, it may be difficult to exit early.
  • This reduces flexibility in forex market interventions.

 

Conclusion

  • The RBI’s $10 billion USD-INR Buy/Sell swap auction aims to inject long-term liquidity, stabilize the Rupee, and manage forex reserves efficiently.
  • The swap mechanism ensures better monetary policy transmission, supports economic growth, and controls inflation risks.
  • However, challenges like counterparty risk, execution complexity, and liquidity constraints must be managed effectively.
  • The success of swap auctions depends on RBI’s strategic forex interventions, global economic conditions, and domestic financial stability.

 

Source: https://www.thehindu.com/business/rbi-to-conduct-usd-inr-swap-auction-of-10-bn-for-3-years-tenor-to-inject-liquidity/article69247559.ece