Dollar-Rupee Swap to Directly Influence Rupee Value & Liquidity

Dollar-Rupee Swap shall now be resorted to infuse durable liquidity into the economy to ease persistent tight liquidity in the banking and financial system instead of Open Market Operations, which suggests that Reserve Bank of India wants to use and develop alternate instruments to manage liquidity. RBI announced that this three-year currency swap scheme shall open on Tuesday 26 March 2019, under which the central bank will purchase $5 billion from banks in exchange for rupees. RBI will infuse as much as ₹35000 crore into the system in one shot at a time when liquidity generally tends to be squeezed.

Open Market Operations, traditionally resorted to by RBI, refer to purchase and sale of Government securities (G-Secs) by RBI from / to market with the objective to adjust rupee liquidity conditions in economy on a durable basis. RBI sells government securities in the markets and banks purchase them.

Dollar-Rupee Swap is a useful addition to the RBI’s policy toolkit as it offers the central bank a chance to directly influence both the value of rupee and amount of liquidity in the economy at the same time using a single tool:

• Dollar-Rupee Swap arrangement will inject fresh liquidity into the economy.
• It will have implications for the currency market as it helps shore up the RBI’s dollar reserves.
• It is a way to earn some interest for Banks out of the Forex reserves lying idle in their kitty.
• It can be an effective way to lower private borrowing costs in the aftermath of liquidity crisis in non-banking financial sector.
• It can be an effective way to lower private borrowing costs.
• Greater availability of liquidity would benefit businesses as banks are likely pass on the benefit of lower rates to their borrowers.
• De facto cap on government’s borrowing costs will remain intact if banks opt to invest in safe government securities at low yields, as they have done in the past.
• If banks find alternative ways to deploy their money, Dollar-Rupee Swap arrangement could end up raising borrowing costs for the government, punishing it for fiscal indiscretion.

RBI had last used currency swap route in late 2013 with the objective to mainly to shore up foreign exchange reserves and support Rupee after it had depreciated sharply against the USD in a short span of time. RBI had then raised over USD 32 billion through that swap window of 3-5 years, but had to provide a steep discount on the cost of swapping dollars to rupees on a fully hedged basis (in relation to the prevailing market rate).