The Reserve Bank of India (RBI) is using forex market tools to inject cash into the banking system, which is soon set to witness large outflows on account of advance tax payments.
The central bank has over the past few days undertaken short-term ‘buy-sell’ foreign exchange swaps in the currency market, which entail purchasing US dollars immediately and then contracting to sell them later, bank treasury executives said.
In the process, the RBI has kept a lid on overnight borrowing costs and increased its foreign exchange reserves while ensuring that its inflation-fighting stance of withdrawing accommodation is not diluted through actions that could bring down bond yields sharply.
“The RBI did a buy-sell cash-based swap on May 31 for around $2 billion (around ₹16,600 crore) which will mature at the end of June. This will take care of some of the liquidity tightness that will affect the banking system when the quarterly advance tax outflows occur at the end of this week,” a senior executive at a foreign bank said on condition of anonymity.
When the RBI purchases dollars from banks, it releases rupees into the banking system. The timing of the swap transactions seems to have been adroitly tailored to match large-scale redemptions of government bonds towards the end of the month. Bond redemptions release funds to banks and ease tight liquidity conditions in the system.
On June 22, a government bond with an outstanding amount of ₹48,353.35 crore is set to mature, while another government bond worth ₹56,000 crore will mature on June 27, RBI data showed.
Before this, deficit liquidity, as measured by banks’ borrowings from the RBI, may shoot up to around ₹2 lakh crore due to the advance tax payments, traders said. The central bank, which reported record-high foreign exchange reserves worth $651.51 billion as of May 31, had stepped up dollar purchases in the last week of the previous month amid tight liquidity conditions brought on by a slow pace of government spending due to the elections.
“In the last week of May, we estimate around ₹42,000 crore worth of liquidity infusion through FX operations by the RBI. These included a combination of fresh purchases, swap maturities and fresh swaps,” the foreign banker said.
FORWARD PREMIA
The impact of the RBI’s actions in the forwards segment of the foreign exchange market has been felt in dollar-rupee forward premia, which have declined sharply.
“RBI had some (dollar) sale contracts amounting to $2 billion due in early June which it has reportedly rolled over to end June which has brought forward premiums down by 15 bps from a near term high of 1.75% to 1.60%,” said Anil Kumar Bhansali, head of treasury at Finrex Treasury Advisors.
“Also, the government needs to step up spending after the elections on schemes like Kisan Nidhi and some others. Possibly some of these swaps are providing rupee liquidity to the market,” he said.
The forward premia, which reflect the interest rate differential between the US and India and represents hedging costs for importers and returns on dollar sales for exporters.
