RBI dollar-rupee swaps push fx hedging costs to two-month lows

Aggressive buy-sell dollar/rupee swap operations by the Reserve Bank of India over the past 10 days have pushed foreign exchange hedging costs to their lowest levels in two months, while contributing to a recovery in the rupee ahead of a closely watched monetary policy decision.

One-year hedging costs have fallen sharply from a mid-May peak of 3.50% to 2.92%.

During the same period, the rupee strengthened from a record low of 96.96 per US dollar to 94.7275 before easing back to 95.6875.

Market participants said the decline in forward premiums and the rupee’s recovery were largely driven by the RBI’s spot dollar sales combined with buy-sell swap transactions.

These operations are designed to offset the impact of foreign exchange intervention on domestic rupee liquidity.

Focus on the upcoming policy decision

The move in currency markets comes ahead of the RBI’s monetary policy decision scheduled for Friday.

The central bank is widely expected to keep interest rates unchanged despite the rupee’s 6.5% decline this year, which has been linked to an oil price shock driven by the Iran war and foreign equity outflows.

The policy review is taking place at a time when financial markets are anticipating measures aimed at boosting dollar inflows and supporting the domestic currency.

A treasury official at a large private bank said the engineered fall in forward premiums might have been linked to measures the RBI could announce.

The official did not provide additional details.

Shift in RBI’s swap strategy

According to a currency trader at a mid-sized private-sector bank, the RBI’s recent foreign exchange swap activity marks a significant shift from its earlier approach.

The trader said there has been a notable change in the central bank’s participation in the swap market, where it had previously been largely absent.

This shift has led to a substantial repricing in forward contracts.

Market estimates of the RBI’s swap activity vary considerably.

Lower-end estimates suggest that the central bank has conducted around $2 billion worth of swap transactions during the past 10 days.

Bankers said the operations have primarily been concentrated in the 12- to 18-month segment of the market.

This represents a departure from the RBI’s traditional preference for swaps with maturities of less than one year.

The focus on longer-duration swaps has contributed to a decline of more than one rupee in two-year forward points from recent highs.

An economist at a private-sector bank said the use of longer-tenor swaps provides the RBI with greater flexibility in managing its expanding forward book.

All bankers and market participants cited in the report spoke on condition of anonymity because they were not authorised to speak publicly.

Liquidity impact remains in focus

Despite the RBI’s buy-sell swap operations, bankers said the measures have not completely neutralised the liquidity effects of the central bank’s spot foreign exchange interventions.

As a result, the RBI has continued to inject funds into the banking system through variable rate repo operations to maintain adequate liquidity conditions.

The central bank’s recent actions have therefore influenced both currency market pricing and domestic liquidity management, with market participants closely monitoring whether additional measures will emerge from the upcoming policy announcement.