The Reserve Bank of India (RBI) recently conducted a dollar-rupee swap auction amounting to USD 5 billion. This initiative is part of RBI’s effort to manage liquidity in the financial system, and it is expected to lead to an increase of dollars and a reduction of the rupee flow in the same system. This measure anticipates aiding in reducing inflationary pressure and strengthening the value of the rupee.
Explaining the Dollar-Rupee Swap Auction
A dollar-rupee swap auction is a foreign exchange tool that allows the central bank to utilize its currency to acquire another one. Under this scheme, the central bank buys dollars from banks in exchange for Indian Rupees (INR), and an agreement takes place instantly to sell the dollars back at a future date.
The RBI used this method by selling USD 5.135 billion to banks and simultaneously agreed to buy back those dollars at the end of the agreed-upon period. This move is meant to help the central bank acquire dollars from the seller at the lowest possible premium for the two-year tenor.
Why Is RBI Implementing It Now?
There is currently a surplus liquidity in the system estimated at Rs 7.5 lakh crore. This surplus needs to be reduced to manage inflation. Traditional methods for achieving this include increasing the repo rate or increasing the Cash Reserve Ratio (CRR), but these may have negative implications on the economy such as interrupting the transmission of monetary policy.
Therefore, RBI has chosen to use different tools such as the Variable Rate Reverse Repo Auction (VRRR) last year. However, recent VRRR auctions were undersubscribed by banks since the cash market offered instant and more favorable yields. Consequently, the RBI decided to resort to a longer-term liquidity adjustment tool – forex auctions.
The Expected Impact of the Swap
The anticipated outcomes of the dollar-rupee swap auction include a reduction in liquidity, a strengthening of the rupee, and containment of inflation. Major impacts will be seen in:
1. Liquidity: The overall liquidity which currently averages around Rs 7.6 lakh crore will experience a decrease.
2. The Indian Rupee: The influx of dollars into the market is expected to strengthen the rupee, which already has reached the 77 level against the US dollar.
3. Inflation: The RBI usually reduces liquidity when inflation appears to be rising sharply.
Understanding the Liquidity Management Initiative
RBI’s liquidity management is defined as the framework and set rules that the central bank follows to control the amount of bank reserves, consequently controlling their price (i.e., short-term interest rates) to align with its ultimate goals, such as price stability.
The Liquidity Management Initiative is a monetary policy tool that allows banks to borrow money through repurchase agreements or make loans to the RBI through reverse repo agreements. Various instruments under this framework include the Repo/reverse repo auction, Marginal Standing Facility (MSF), and Forex Swaps.
What Does Expansionist Monetary Policy Look Like?
If the RBI decided to adopt an expansionist monetary policy, it would involve actions such as cutting and optimizing the Statutory Liquidity Ratio, increasing the Marginal Standing Facility Rate, and cutting the Bank Rate and Repo Rate. However, every policy comes with its implications and must be applied considering the specific needs and conditions of the economy.
Sources: IE
