The Reserve Bank of India (RBI) has deployed a new strategy to manage surplus banking system liquidity and address inflation concerns. This approach involves large-scale transactions in the forward segment of the foreign exchange market. Over the past few days, the RBI has executed multiple tranches of short-term 'sell-buy' swaps, amounting to approximately $8 billion. This marks a significant departure from the central bank's recent practices, as it had refrained from conducting such transactions for several months.
The decision to utilize sell-buy swaps in the foreign exchange market is timely, given the recent surge in crude oil prices and elevated US market rates. These factors have kept the Indian rupee trading near its historic lows against the US dollar, albeit with less intensity than the previous year.
Sell-buy swaps involve the sale of US dollars with a commitment to repurchase them later. This approach effectively removes rupee liquidity from the banking system. The RBI has been taking measures to reduce surplus liquidity within the banking system, as an excess of funds in the hands of lenders can contribute to inflationary pressures.
Traders have reported that the RBI conducted sell-buy swaps in the forwards market with contract maturities ranging from September 11 to 15, totalling around $2 billion on September 7. Additionally, on September 4, the central bank executed sell-buy swaps maturing between September 6 and 8, with transaction sizes estimated between $4 billion and $6 billion.
Market experts suggest that these recent actions in the forwards market indicate the RBI's intention to expand its toolkit for liquidity management. This is notable because, under normal circumstances, the RBI offsets its dollar sales in the spot market with buy-sell swaps in the forwards market to counteract the liquidity-draining effects of such transactions.
Treasury officials emphasize that these recent sell-buy swaps appear to target INR liquidity specifically. While the RBI typically employs buy-sell swaps in conjunction with USD/INR spot sales, the current focus on sell-buy swaps suggests a more targeted approach to address rupee liquidity. This strategy is particularly relevant given the periodic fluctuations in systemic liquidity, driven by volatile government balances. In this context, FX swaps could prove to be a more effective tool than other options like VRRR (variable rate reverse repo auctions) or ICRR, which have different impacts on liquidity and are less immediate in their effects.
