A $5 Billion Currency Swap Is RBI’s Answer to India’s Cash Needs

by | Mar 18, 2019 | news updates | 0 comments

The ripple effects of the Reserve Bank of India’s unusual move to use foreign-exchange swaps to ease a liquidity deficit at banks ahead of national elections were felt across local currency, stocks and bond markets on Thursday.

Sovereign bonds fell as traders speculated that the measure would reduce the need for the central bank to buy debt via open-market operations, removing a key support for the market. The rupee weakened as some analysts saw the decision as a signal that the RBI isn’t comfortable with the currency’s recent gains, while some financial stocks cheered the planned liquidity infusion.

The RBI will hold a $5 billion foreign-exchange swap auction for a three-year tenor on March 26, it said late Wednesday. The plan comes as India is estimated to spend an unprecedented 500 billion rupees ($7.2 billion) to conduct a six-week-long vote starting next month. That, along with a seasonal shortage before the fiscal year-end, is putting a strain on banking liquidity.

Below is the impact the RBI’s move has had on different asset classes, with comments from market watchers. For more details on the swap plan itself, click here.


The yield on India’s most-traded 2028 sovereign debt rose two basis points to 7.56 percent.

If the FX swap “becomes a regular tool, it reduces the need of OMO buybacks,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. The RBI is forecast to have spent a record 3 trillion rupees on OMO purchases in the year ending March, acting as a key support for the market.

That said, the injection of liquidity via the swap auction should support shorter-term bonds, according to some analysts, as investors will be wary of the longer end due to the government’s heavy borrowing from April to plug its budget gap.

Yield on India's 2028 bonds rises after RBI's move


The rupee was down 0.1 percent against the dollar on Thursday, halting a three-day gain. Even so, it remains Asia’s top performer over the past month as foreign inflows into equities and bonds have surged, and the nation’s military tension with Pakistan has eased. Stocks have attracted $4.1 billion so far this year.

“The move prima facie looks to be rupee negative, amid higher rupee-liquidity creation,” said Madhavi Arora, an economist at Edelweiss Securities Ltd. “However, if the dollars come via the offshore foreign banks’ route, this particular move per se would be rupee agnostic.”

The RBI had used foreign-exchange swaps in 2013 to stem the losses suffered by the rupee amid an emerging-market rout, asking banks to bring in dollar inflows from non-resident Indians.

“The RBI is telegraphing to the market that it is not comfortable with the current rupee strength,” besides augmenting money supply to manage the fiscal year-end liquidity needs, said Anindya Banerjee, a currency analyst at Kotak Securities Ltd. in Mumbai.

Banking system liquidity deficit has been on the rise in recent months

Forward Premia, MIFOR

While the rupee in the spot market showed a muted reaction, one-year dollar/rupee forward premia slipped 28 basis points to 3.60 percent. Some analysts said that the impact of the RBI move on spot will depend on how the banks source dollars to offer to the RBI at the auction.

The lower premiums will reduce hedging costs for foreign investors at a time when the central bank has opened a special route for overseas investment in debt.

3-year Mifor rate declines to lowest since Jan. 2018

Finance Stocks

Some banking stocks rose along with shares of non-banking financial companies in response to the planned fund infusion.

“It addresses the liquidity tightness in the financial system and will help revive credit, said Prakash Pandey, head of research at Delhi-based Fairwealth Securities Ltd.

Dewan Housing Finance Corp. rose as much as 6.9 percent and was the top performer on S&P BSE Finance Index earlier in the day. JM Financial Ltd. climbed as much as 5.8 percent, while Indiabulls Housing Finance Ltd. advanced as much as 3.7 percent.


The move is also likely to boost overseas interest in Indian corporate bonds by lowering hedging costs.

“A lower hedge cost should incrementally incentivize offshore flow into Indian ‘carry’ assets, chiefly corporate bonds,” said Suyash Choudhary, head of fixed income at IDFC Asset Management Ltd.

This move further enhances the appeal of two-five year AAA corporate bonds on the margin, said Choudhary.


** This article was originally posted on Bloomberg by Kartik Goyal and Subhadip Sircar


Smart swap


RBI’s forex swap may cool short-term bond yields and reduce hedging costs for domestic firms


The Reserve Bank of India’s decision to deploy a new instrument from its armoury, a foreign exchange swap auction, throws a much-needed liquidity lifeline to nervous money markets at the fag-end of the financial year. Though the central bank has been regularly infusing cash into the markets through Open Market Operations (OMOs) since the IL&FS default last year, the liquidity situation is expected to worsen over the next couple of weeks on advance tax and GST payments, as well as election spending — which is known to siphon out currency from the market. This pre-emptive move from the RBI may help partly bridge this liquidity deficit and shore up sentiment.

The swap transaction for $5 billion scheduled on March 26 is materially different from OMOs in the sense that authorised dealers, mainly banks, will be allowed to deposit US dollars with the central bank in exchange for rupees, with an agreement to reverse the transaction at a fixed exchange rate at the end of three years. The final exchange rate will be decided by an auction where banks will bid on the forward premium they are willing to pay to participate in this swap. If successful, the auction is expected to immediately release $5 billion worth of rupee liquidity into the banking system, thus cooling short-term bond yields. There are also three other advantages to the RBI using foreign exchange swaps to bolster market liquidity at this juncture. The auction, if successful, will immediately shore up RBI’s foreign exchange reserves by $5 billion. Banks which are currently short on SLR securities and cannot participate in OMOs, will receive liquidity infusions too. The swap deal may temporarily bring down hedging costs in the domestic market, helping local firms with foreign exchange exposures hedge their open trade or loan exposures. The RBI had last used foreign currency swaps to attract dollar FCNR deposits from NRIs and prop up the rupee during the taper tantrum months of 2013. But this swap is unlikely to have a similar effect on the exchange rate, given that the dollars can be domestically sourced. In fact, the currency market has already interpreted this move as a signal from the RBI that it is uncomfortable with an appreciating rupee.

While it is good to see the RBI take cognisance of the liquidity crunch, instead of being in denial mode, and exploring new means to address it, it remains to be seen if this move really opens the liquidity tap to distressed market borrowers such as NBFCs. The forex swap, like OMOs, essentially puts more money in the hands of banks, who in turn have discretion to decide whether to step up credit to lower-rated borrowers. The RBI still needs to come up with a structural solution to address the liquidity issue that is endemic to India’s shallow corporate bond market.


** This article was originally posted on BusinessLine