Rupee & Dollar Swap Auctions

GS 3 – ECONOMY

Context: The Reserve Bank of India (RBI) has announced a USD/INR buy/sell swap auction worth $10 billion, aiming to inject ₹86,000 crore into the banking system.

Understanding Rupee & Dollar Swap Auctions

Rupee-Dollar swap auctions are monetary tools employed by the RBI to manage liquidity in the economy and curb currency volatility.

• Mechanism:
  In these auctions, banks sell US dollars to the RBI in exchange for rupees in the initial leg, agreeing to repurchase the dollars at a pre-determined rate on a future date.

Who Conducts the Swap Auctions?

The Reserve Bank of India (RBI) carries out these auctions as part of its monetary policy toolkit to regulate liquidity and stabilize the foreign exchange market.

How Do Rupee-Dollar Swap Auctions Work?

1. First Leg (Buy Phase):
   • Banks sell US dollars to the RBI.
   • In return, they receive Indian Rupees (INR), boosting rupee liquidity in the market.
2. Reverse Leg (Sell Phase):
   • After the agreed swap period, banks buy back the US dollars from the RBI at a predetermined price.
   • This phase withdraws the injected rupee liquidity from the system.

Key Features of the Swap Auctions:

• Tenor:
  • The duration of the swap can vary, typically ranging from short-term (6 months) to long-term (3 years or more).
• Liquidity Management:
  • The primary objective is to either infuse or absorb rupee liquidity, depending on prevailing market conditions.
• Utilization of Forex Reserves:
  • The RBI uses its existing foreign exchange reserves to conduct these swaps, ensuring efficient currency flow management.
• Stabilizing Exchange Rates:
  • Such auctions help mitigate sharp fluctuations in the rupee’s value against the US dollar, promoting market stability.

Impact on the Indian Economy:

1. Enhances Banking Liquidity:

• • The recent swap injects ₹86,000 crore into the banking system, helping address the ongoing ₹1.7 lakh crore liquidity shortfall.

2. Improves Monetary Policy Transmission:

• • By aligning money market rates with the RBI’s policy stance, the swap aids smoother monetary policy transmission.

3. Supports the Rupee:

• • Strengthens the INR by reducing depreciation pressures and ensuring forex market stability.

4. Boosts Economic Growth:

• • Improved liquidity enables banks to extend more credit, promoting investment, consumption, and overall economic growth.

5. Manages Inflation Risks:

• • As the liquidity infusion is backed by future forex obligations, it limits inflationary pressures, maintaining price stability.