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Informist, Friday, Feb. 28, 2025

 

By Pratiksha

 

NEW DELHI – The Reserve Bank of India's decision to conduct its biggest ever $10-billion dollar/rupee swap auction on Friday did not catch currency market players off guard, as most of them saw it coming due to the current liquidity tightness and the central bank's large net short outstanding dollar/rupee forward book. In fact, market players now expect the RBI to conduct more such swap auctions in the future.

 

On Feb. 21, the central bank announced it would conduct a $10-billion dollar/rupee buy/sell swap auction on Friday, wherein it would buy dollars for immediate delivery and sell them for delivery after three years. The announcement came less than a month after the apex bank held a $5-billion dollar/rupee buy/sell swap auction on Jan. 31 for six months.

 

Ever since the RBI introduced foreign exchange swaps in its liquidity management toolkit back in March 2019, such swap auctions have been few and far between. But now, the central bank faces enough compulsions to make these a routine affair.

 

To begin with, the RBI has a massive forward book that needs to be managed. The size of the RBI's net short outstanding dollar/rupee forward book has only been growing since March 2024 and was at a whopping $67.94 billion at the end of December.

 

Currency traders estimate that the central bank's outstanding forward dollar sales at the end of January would amount to over $75 billion, of which at least $40 billion would represent onshore sales. As the RBI continues the process of 'onshoring' its book, it is likely to allow its offshore NDF sales to mature and sell dollars in the onshore spot and forwards segments to limit the pressure on the rupee. This implies that the RBI will have to persist with onshore buy/sell swaps, either through auctions or in the secondary market.

 

The RBI's entire forward book has a maturity period of up to one year. If the central bank was to deliver dollars against its outstanding onshore forward sales, it would end up draining around INR 3.5 trillion from the banking system over the next one year. At a time when the banking system is already grappling with a cash crunch and capital flows have dried up, the central bank would struggle to plug such a gaping liquidity hole.

 

Banking system liquidity has been in deficit since mid-December, with market participants attributing the tightness to the RBI's spot dollar sales in order to soften the rupee's depreciation. The net liquidity injected by the RBI--a proxy for systemic liquidity deficit--has averaged around INR 1.53 trillion this month. The RBI has no choice but to roll over its forward dollar sales and ideally, elongate their maturity profile as it is doing with the three-year swap on Friday.

 

"It (more swap auctions) all depends on how much more intervention is required and how is the ladder on the maturity of the forward book is panning out. That will define whether they will be able to do the buy/sells in the market, or will they go for the swap window," said Ashhish Vaidya, managing director and country treasurer, DBS Bank India.

 

It is typical for the RBI to deploy buy-sell swaps to postpone the drain of rupee-denominated liquidity when it is selling dollars in the spot market. This time around, however, there is also a need for the central bank to use the instrument to mop up the dollar glut that has built up in the Indian financial system since December.

 

"I think the RBI is trying to correct distortions in liquidity (both INR and USD) through the $10-billion USD-INR swap auction, which stemmed from its FX interventions. I don't think this is done to artificially increase headline reserves," said Nitin Agarwal, head of trading at ANZ Bank India.

 

"If RBI continues to intervene aggressively, more swap auctions may be needed. The impact of these measures on liquidity, both INR and USD, may necessitate further actions. The RBI has been managing INR liquidity through other routes but may have realised that USD liquidity in the banking system is also getting distorted."

 

With the upcoming buy/sell swap auction and potentially more in the pipeline, market participants are of the view that dollar/rupee forward premiums are in for highly volatile times.

 

Forward premiums have been on a downward journey since December after the central bank actively started conducting buy/sell swaps in the dollar/rupee forward market to sterilise its spot intervention. Since December, the premium on the one-year dollar/rupee forward contract has slumped over 20 basis points.

 

AUCTION DEMAND

Some dealers said that the $10-billion swap auction is also the RBI's attempt to move more its offshore short positions onshore. Because of this, it may draw demand from entities looking to roll over their long dollar positions. "They are trying to shift their offshore shorts to onshore forward shorts. It will help them manage things better. I think this (swap auction) will be a combination of fresh sales and rollovers," said a senior treasury official at a state-owned bank.

 

At the $10-billion swap auction, market players expect strong participation from corporates as well as state-owned banks and private banks, owing to ample dollar liquidity in the system. Dealers said there would be strong participation from corporates, especially as the tenure of the swap is longer than the previous one. "The (FX swap) will provide an avenue for importers to hedge their exposures, making it a better option than the 6-month swap as the 3-year tenor is more suitable," Agarwal said.

 

And a swap auction as big as $10 billion sailing through easily only increases the scope for more such auctions in the near term, dealers said.  End

 

US$1 = INR 87.20

 

Edited by Avishek Dutta

 

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