RBI dollar swap mechanism is a way adopted by the apex bank to improve liquidity in the system and also curb any volatility in the rupee movement against the dollar. Herein the bank dollar balance is converted into rupees.
Also, the dollar swap phenomena can well be compared to the apex bank's OMO or open market operations as it instills liquidity into the economy. Furthermore, for the India's forex reserve situation it bolsters its dollar reserves and checks any steep appreciation in the rupee, thereby indirectly supporting exporters.
Recent developments around RBI’s dollar swap move
In a view to foster liquidity into the system, RBI conducted dollar swap on March 26 for a targeted amount of $5 billion. But during its operation, it received bids for as much as nearly $16.3 billion.
And in view of it, the RBI yet again announced a dollar swap of $5 billion on April 23.
Modus operandi of RBIs dollar swap
The dollar swap works similar to a repo wherein the sale and re-purchase price is predetermined. The close-ended swaps are open to banks and have a term of 3 years. And in the swap auctions, banks will make the bid on forward rate that is lower than the market rate and monetize their dollar holdings and the RBI builds Forex reserves.
Why RBI’s dollar swap?
It is to overcome the liquidity deficit in the economy which still prevails despite RBI infusion Rs. 40,000 on a month-on-month basis through open market operations. The liquidity shortfall as of December 2018 came in at Rs. 100,000 crore. Also, the apex bank absorbed bond issuance in its balance sheet by a huge 75%.
Broader implications of the RBI’s dollar swap auction moves
In a broad way, 3 objectives will be realized i.e. liquidity will be strengthened by Rs 35,000 crore each month at $5 billion. The country's Forex reserves will also get a boost by $5 billion and there will be still scope for further enhancement in reserves. It is pointed that Forex reserve of the country has been dragged to just 9 months of imports and this gap can be met by the Forex swap move.
Also, as dollar will remain in demand from the RBI, any gains in the rupee will remain in check.