Context: The Reserve Bank of India (RBI) has announced a $10 billion USD-INR Buy/Sell swap auction with a tenure of three years, scheduled for February 28, 2025. This move is aimed to inject liquidity into the banking system and stabilise Indian currency.
Relevance of the Topic: Prelims: Forex Buy/Sell Swap, AD Category-1 Banks; Measures used by RBI to inject liquidity.
About Forex Swap Auction
- Forex Swap Auction is a financial instrument used by the Reserve Bank of India (RBI) to manage liquidity in the financial system.
- In the Buy/Sell swap 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).
| Criteria | Forex Buy/Sell Swap | Forex Sell/Buy Swap |
| What does the RBI do? | RBI buys dollars with an agreement to sell the dollars at a future date and at a fixed exchange rate. | RBI sells dollars with an agreement to buy back the same amount of dollars at a future date and at a fixed exchange rate. |
| When is it adopted? | Surplus of dollars → Rupee Appreciation pressureHence, RBI buys dollars and injects Rupee to control Rupee Appreciation. | Shortage of dollars → Rupee DepreciationHence, RBI sells dollars and sucks out Rupee to control Rupee Depreciation. |
| What does it lead to? | Potential Rupee Devaluation: Decrease in value of Rupee due to RBI’s Intervention | Rupee Revaluation: Increase in value of Rupee due to RBI’s Intervention |
| Impact on Rupee Liquidity | Increases Rupee Liquidity | Decreases |
| Impact on Rate of Interest on Loans | Increase in Rupee Liquidity → Decrease in Rate of Interest on Loans | Decrease in Rupee Liquidity → Increase in Rate of Interest on Loans |
| Impact on Forex Reserves | RBI Purchases dollars → Increase in Forex Reserves (temporarily) | RBI sells dollars → Decline in Forex Reserves (temporarily) |
Significance of 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.
RBI’s proposal for USD-INR Buy/Sell Swap Auction
- Details of the auction:
- Swap amount: $10 billion
- Tenure: 3 years
- Key features:
- Participants must place their bids in terms of the premium they are willing to pay to RBI for the tenure of the swap. Expressed in paisa terms up to two decimal places.
- The auction would be a multiple-price based auction, i.e., successful bids will get accepted at their respective quoted premium.
- Authorised Dealers (ADs): Category-1 banks will be the eligible entities to participate in the auction.
- Under the swap auction, minimum bid size would be USD 10 million and in multiples of USD 1 million thereafter. The eligible participants are allowed to submit multiple bids.
- RBI reserves the right to:
- Decide on the quantum of US Dollar amount to be accepted in the swap auction.
- Accept offers for less than the aggregate notified US Dollar amount.
- Accept marginally higher than the notified US Dollar amount due to rounding-off effects.
- Accept or reject any or all the offers either wholly or partially without assigning any reason.
Authorised Dealers (ADs) – Category-1 Banks
- RBI gives an AD Category-1 Bank permission to deal in foreign exchange transactions.
- AD stands for Authorised Dealer.
- Category-1 is the highest authorised dealer category in India's foreign exchange transactions.
- These banks are allowed to carry out a wide range of activities related to foreign exchange, including:
- Buying and selling foreign currency
- Outward remittance of funds abroad
- Issuance of letters of credit and bank guarantees.
- They act as intermediaries between the buyers and sellers of foreign currencies and help to provide liquidity in the foreign exchange market.
Recent Liquidity Issues in the Indian Banking System:
- The Indian banking system encountered its worst liquidity crunch in more than a decade in January 2025. The liquidity deficit peaked at Rs 3.15 lakh crore on January 23, its lowest level in nearly 15 years.
- The deficit led to increased dependence by banks on market borrowing, thereby keeping interbank call money rates (rate at which banks lend to each other) consistently above the policy repo rate of 6.50%.
- The RBI has been selling dollars to stabilise the rupee, thereby sucking out an equivalent amount in rupee from the system. RBI’s outstanding net forward sales of the dollar surged to $67.93 billion as of December 31, 2024, as the central bank intensified its efforts to stabilize the rupee.
RBI’s measures to ensure liquidity
- The RBI had infused over Rs 3.6 lakh crore of durable liquidity into the banking system in Jan-Feb 2025 through:
- Debt purchases
- Forex swaps (exchanging foreign currency with banks)
- Longer-duration repos.
- Other measures included:
- Several variable rate repo (VRR) auctions
- $5 billion dollar-rupee swap
- Rs 60,000 crore Open market operations (OMO) purchase auctions of government securities.