Why a forex swap by RBI?
A bank usually sources dollars for its clients from the inter-bank market. In India, oil-marketing companies are the biggest buyer of dollars. But, in times of sell-off in financial markets, the demand for foreign exchange from FPIs (foreign portfolio investors) can be a swift one. This creates shortage of dollars in the inter-bank and leads to increased weakness in rupee, to a level which could make RBI uncomfortable.
With rupee near the life-time lows of 74.38 seen in October 2018, RBI decided to intervene and announced a Sell/Buy swap to directly provide foreign exchange to banks.
RBI Announces USD/INR Sell Buy Swaps - March 12, 2020
What is a Swap?
A swap has two legs or two transactions. The time period between the two transactions is the tenor of the swap. In the first leg on March 16, 2020, RBI would sell/ provide dollars to a bank and in return take rupees . The second leg on September 18, 2020, involves giving back dollars by banks to RBI and receive rupees in return. Tenor of this swap will be 6 months.
First-Leg of Swap
In first-leg, all the bidding banks would place their bids for the premium they are ready to take from RBI when they return their dollars. Premium is the extra rupees that RBI would pay in the second leg over and above what it received for the dollars in the first leg. This is because the dollar trades at a premium over the spot rate for a transaction date in future. Hence, the forward value of USDINR is equal to spot + some premium.
RBI would give dollars to qualifying banks at the reference rate, which prevails on the day of the auction. Reference rate is published on the site of FBIL. The actual exchange of dollars would take place two days later as it would be a settlement on “spot-basis”. RBI would credit dollars in the nostro accounts of the bank and debit the current accounts that banks maintain with RBI. Banks would provide the details of the nostro accounts to RBI’s back-office. A nostro account refers to a foreign-currency account that a bank holds in another bank overseas.
Second Leg of Swap
In the second leg, banks would return the dollars and receive rupees equal to the spot + cut-off premium decided at the day of auction.
Impact on Rupee
With dollars already in hand, the demand for dollars in the inter-bank market would reduce and arrest weakness in rupee, at least for sometime.
To be sure of the price at which they would buy dollars to return to RBI, banks would enter into 6-months forward contracts and push up their premium. It has been seen that as the dollar rises versus rupee like the present scenario, exporters try to withhold (not convert) dollars in their EEFC accounts expecting better value for their dollar funds. This leads to further shortage of dollars in the inter-bank market. With expected fall in spot rates but higher forward premium, exporters may start to sell dollars and importers may postpone dollar purchases, further controlling the volatility in rupee.
In the following period, if the Asian currencies remain weak and a sell-off in local stocks by FPIs persists, then the move by RBI may not be sufficient enough to arrest the fall in Rupee.