What does RBI’s $5 billion dollar-rupee swap mean? – INSIGHTSIAS

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GS Paper 3:

Topics Covered: Indian Economy.

 

Context:

The Reserve Bank of India (RBI) has conducted a $ 5 billion dollar-rupee swap auction as part of its liquidity management initiative, leading to infusion of dollars and sucking out of the rupee from the financial system.

 

What is a Dollar–Rupee Swap auction?

It’s a forex tool whereby the central bank uses its currency to buy another currency or vice versa.

  • In a Dollar–Rupee buy/sell swap, the central bank buys dollars (US dollars or USD) from banks in exchange for Indian Rupees (INR) and immediately gets into an opposite deal with banks promising to sell dollars at a later date.

 

Why do Central Banks engage in it?

  • Forex swaps help in liquidity management.
  • It also, in a limited way, helps in keeping the currency rates in check.
  • A dollar–rupee buy/sell swap injects INR into the banking system while sucking out the dollars, and the reverse happens in a sell/buy swap.

 

Why is RBI resorting to it now?

Surplus liquidity in the system is pegged at Rs 7.5 lakh crore, which needs to be curbed to keep a tab on inflation.

  • Usually, the central bank will resort to traditional tools such as increasing the repo rate or increasing the cash reserve ratio (CRR), but this can have a negative implication on the economy.
  • Therefore, the RBI used a different toolkit – variable rate reverse repo auction (VRRR) last year.

 

Impacts:

Forex swaps are intended for liquidity management. Therefore, their impact on currency is only incidental.

The RBI resorting to selling USD in two tranches will keep a check on Rupee’s volatility and help curb its depreciation to some extent.

For the bond market, the exercise may have a pronounced impact.

  • Bonds yields are already on an incline. Liquidity intervention through swaps indicates the RBI’s plan to use a different toolkit rather than the traditional ones, and this leaves room for the central bank to buy bonds when needed. Consequently, the strategy will contain bond yields.

 

InstaLinks:

Prelims Link:

  1. What is currency swap?
  2. Impacts.
  3. RBI Monetary Policy tools.
  4. Bond yields.
  5. Bond Yield curve.

Mains Link:

Discuss the significance of RBI Currency Swap.

Sources: Indian Express.

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