Why in news?

The Reserve Bank of India (RBI) will conduct its largest-ever $10-billion dollar/rupee buy-sell swap auction, aiming to address the persistent liquidity deficit in the banking system.  

What’s in today’s article?

• Dollar/rupee buy-sell swap auction
• RBI’s USD-INR Buy/Sell Swap Auction for Liquidity Management

Dollar/rupee buy-sell swap auction

• A Dollar/Rupee Buy-Sell Swap Auction is a foreign exchange (forex) instrument used by the RBI to manage liquidity in the financial system.
• In this mechanism, RBI buys U.S. Dollars from banks in exchange for Rupees (first leg) and agrees to sell them back at a pre-determined future date along with a premium (reverse leg).
• Need for Swap Auctions
  • Liquidity Management: Helps inject or absorb Rupee liquidity in the banking system.
  • Exchange Rate Stability: Reduces volatility in the USD/INR exchange rate by providing liquidity buffers.
  • Foreign Exchange Reserves Management: Enhances the efficient utilization of forex reserves.
  • Inflation & Interest Rate Control: Manages liquidity, indirectly influencing inflation and interest rates.
• Advantages
  • Enhances Market Liquidity: Provides long-term liquidity to banks, supporting credit flow.
  • Stabilizes the Rupee: Helps mitigate pressure on the Rupee during periods of forex outflows.
  • Predictable Cash Flows for Banks: Assists banks in managing forex positions and liquidity planning.
  • Prevents Excessive Volatility: Helps smoothen currency fluctuations, boosting investor confidence.
• Challenges
  • Impact on Forex Reserves: Large-scale swaps can affect RBI’s forex reserves.
  • Dependence on External Factors: Effectiveness depends on global market conditions, capital flows, and interest rate differentials.
  • Market Reaction Uncertainty: If not executed strategically, it may lead to unintended currency speculation.
  • Limited Long-Term Solution: Provides only a temporary fix for liquidity issues; structural reforms may still be needed.

RBI’s USD-INR Buy/Sell Swap Auction for Liquidity Management

• To address the system’s durable liquidity needs, the RBI will conduct a USD-INR Buy/Sell swap auction worth $10 billion for a three-year tenor on February 28, 2025.
• The spot settlement date is March 4, 2025, while the far-leg settlement date is March 6, 2028.
• This swap auction will provide short-term stability to the Rupee, helping mitigate volatility caused by foreign fund outflows.
• The USD-INR spot rate may move towards 86.30.
• Swap Mechanism
  • In the first leg, participating banks will sell USD to the RBI at the FBIL Reference Rate and receive equivalent Rupee liquidity in their current accounts.
    • The FBIL Reference Rate is a benchmark rate for currency pairs, such as the Indian rupee (INR) against the US dollar (USD), euro (EUR), pound sterling (GBP), and Japanese yen (JPY).
    • FBIL stands for Financial Benchmarks India Private Limited.
  • In the reverse leg, banks will repurchase USD from the RBI by returning the Rupee funds along with the agreed swap premium.
• This strategic move by the RBI aims to enhance liquidity, stabilize the Rupee, and maintain exchange rate stability.