Mumbai: The Reserve Bank of India’s $5-billion currency swap could step up the central bank’s efforts for monetary transmission and reduce the need for it to buy debt via open-market operations (OMOs). This could also bring interest rates down and prevent any sharp appreciation in the rupee.
Late Wednesday, the RBI announced a new tool for liquidity creation and decided to inject rupee liquidity for three years through long-term foreign exchange buy/sell swap. Under this, the RBI will buy up to $5 billion from the market via auction on March 26, and simultaneously sell it back to the same counterparties up to March 2022. The banking system will see an infusion of Rs 35,000 crore of rupee liquidity for a three-year period.
“From a more medium-term perspective, this may also imply that the RBI is stepping up efforts for transmission. If RBI has indeed stepped up efforts in this direction, it is very consistent with our expectations from the new governor,” Suyash Choudhary, Head, Fixed Income at IDFC AMC.
While liquidity deficit is fairly comfortable as of now, economists foresee significant tightness in the coming weeks on account of general elections in April-May, transfer payment from the central government (via PM-Kisan scheme) along with few state governments (various schemes) that could also potentially increase the demand for currency in the coming quarters.
The currency in circulation (CIC) continues to increase at a robust pace as per RBI data. The CIC to the GDP ratio touched 10.9 per cent in Q3 FY19 and is on course to touch around 11.2 per cent by the end of Q4 FY19. This would be similar to the pre-demonetization trend of 11-12 per cent, said economists.
“The new tool to infuse liquidity will be helpful in partially alleviating year-end liquidity tightness for the banking system,” they claimed.
A banker said the RBI measure would also reduce short-term interest rates for borrowers and avert any sharp appreciation in the rupee in face of a strong pipeline of flows in the near-term.
According to Shubhada Rao, Senior President and Chief Economist, Yes Bank, “While the primary objective of using auction-based forex swap is to infuse INR liquidity through an alternate channel, there could be other collateral benefits at the same time. The decline in forward premia (especially at the longer tenor) will lower dollar hedging cost for importers.”
