All you wanted to know about RBI's swap auction

Today is not just another day in the Indian currency market. The Reserve Bank of India will be conducting the Dollar-Rupee (USD/INR) swap auction in the morning. This is being done in order to increase rupee liquidity in the market. The size of this auction is $5 billion, and the tenor is three years.

The RBI has different tools through which it injects liquidity into financial markets. Adjusting repo rates and purchasing bonds by conducting open market operations (OMO) are a couple of tools which the RBI uses regularly either to increase or decrease the currency supply in the market. The recently announced ‘swap auction’ which will be conducted today is one such tool. This is being done to increase the supply of rupees in the market. Technically, this activity is being termed as a USD/INR Buy/Sell Swap Auction.

Through this auction, the RBI will buy US dollars from banks totalling to $5 billion. In turn the RBI will pay rupees to the participating banks at the current spot rate. At an average spot rate of 70 per dollar, the RBI will able to infuse about ₹35,000 crore into the system through this auction process.

Simultaneously, the banks will agree to buy-back the same amount of dollars from the RBI after three years — the tenor of this auction. The participating banks have to bid in the auction by quoting a forward premium in terms of paisa that they will pay to buy back the dollars. For example, if the spot exchange rate is 70 to a dollar, say Bank A quotes a premium of 150 paisa and bids for $25 million. So, the bank will get ₹175 crore ($25 million multiplied by the exchange rate of 70). After three years, the bank has to pay back approximately ₹179 crore ($25 million multiplied by the exchange rate of 71.5) to the RBI to buy back $25 million.

Indian financial markets have been undergoing liquidity problems since the IL&FS crisis emerged last year. The market is likely to see even tighter liquidity from a rush to pay advance tax as the financial year end is less than a week away.

In addition to this, the demand for rupees is expected to spike in the coming weeks as a result of a huge spending towards the upcoming general elections that starts next month. So, the timing of the RBI’s auction, at the end of the financial year seems to have taken into account these factors.

For the RBI, the auction will help boost its forex reserves by another $5 billion. The reserves as on March 15, is $405.6 billion. The forex reserve is one tool which the RBI uses to intervene in the currency market at times of abnormal volatility.

From a common man’s perspective, this auction is expected to improve fund availability with the banks. Whether this will moderate borrowing costs in the short term though needs to be seen. But only the Category-I banks are allowed to participate in the auction, not all players in the financial services sector will be able to get the benefits or lower their rates. Also, if the participating banks decide not to loosen up on credit to specific segments such as NBFCs, the credit crunch for them is likely to continue.

From a business perspective, the hedge cost for the importers are likely to come down as increased rupee liquidity is likely to bring down the forward rates. Indeed, the forward premiums have been falling ever since the RBI announced this auction on March 13.

The RBI is deploying a new weapon to enhance market liquidity. Whether it will hit or miss the target, will be known only over time.

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