Dollar Swaps could actually hit three birds with one stone
In the last week of March, the RBI introduced the new concept of dollar swap auctions in the Indian money markets. The first issue of dollar swaps attracted buying interest of $16.3 billion against the offer size of $5 billion. That surely means that there could be more such issues in the future. But what are these dollar swaps and how do they really benefit the markets?
How dollar swaps work?
The dollar swap is an interesting scheme wherein the RBI buys dollars from the commercial banks and pays them rupees instead. This dollar swap is a back-to-back deal with 3-year tenure. The banks are aware that they will be able to covert this money back into dollars at the end of 3 years at a cost that is determined in advance. The RBI has set the pricing in such a way that the swap is slightly more attractive than the market yields. For banks it is a good and profitable way to put their dollar inflows to work. There have been substantial dollar inflows coming into India in the form of FPI flows, NRI remittances, FDI flows etc. The RBI can use these dollars to shore up their dollar reserves and at the same time infuse liquidity into the market. At the same time, since the swap entails purchasing the dollar in exchange for rupees, it has the tendency to prevent the rupee from getting too strong. That is likely to work in favor of the exporters who normally tend to benefit from a strong dollar.
Why is liquidity tight?
Liquidity shortfall in the financial markets has been to the tune of nearly Rs.2 trillion as of the end of March when the income tax and GST payouts become due. The RBI has been infusing nearly Rs.40,000 crore each month but that has not been sufficient. With the liquidity already tight in the aftermath of the NBFC crisis late last year, there is the need to use liquidity infusion in a different way. The traditional OMOs have a limitation because last year nearly 75% of the total bonds issued by the government devolved on the RBI. Dollar swaps offer a way out.
Hitting 3 birds with 1 stone
In a way, the dollar swap auction is like the RBI hitting 3 birds with one stone. Here is how it works. Firstly, the issue of liquidity in the market is addressed without too much of bonds devolving on the RBI books. This is also more effective than a rate cut in the current market conditions. Secondly, this move can offer a boost for exporters. When the RBI buys dollars, it makes the dollar stronger vis-à-vis the rupee. This makes exporters more competitive. Lastly, the dollar swaps also bolster the RBI forex reserves. From a high of $430 billion, the reserves have fallen to around $400 billion. That is just about 9 months of imports, which is lower than what BRC nations maintain. The swap can actually achieve more with lesser side effects! ©
Targeted Keywords – Dollar Swaps, dollar swap lines, Central bank liquidity swap, Swap Lines Definition, Talks for Dollar Swap Agreement, financial markets, income tax