RBI announces $5 billion dollar-rupee swap to ease liquidity pressure

The Reserve Bank of India (RBI) on Wednesday announced a dollar/rupee buy-sell swap auction worth $5 billion with a tenor of three years, scheduled for May 26, as the central bank seeks to manage liquidity conditions amid continued pressure on the Indian currency.

The RBI said the decision followed a review of current and evolving liquidity conditions.

The move comes as the central bank continues intervening in the foreign exchange market by selling dollars from its reserves to defend the rapidly weakening rupee.

RBI move aimed at easing liquidity pressure

The central bank’s intervention in the currency market has led to a withdrawal of rupee liquidity from the banking system.

Dollar sales by the RBI absorb rupees from the market, which can tighten liquidity conditions and potentially push up interest rates.

India’s banking system liquidity remains in surplus, but the surplus has narrowed significantly.

According to the report, liquidity currently stands at 1.51 trillion rupees ($15.6 billion), equivalent to around 0.6% of total deposits in the banking system.

The RBI’s swap auction is expected to inject liquidity back into the system while simultaneously addressing volatility in forward currency markets.

Rupee weakens to fresh record low

The Indian rupee has remained under pressure in recent weeks as geopolitical tensions and rising crude oil prices weighed on the currency.

The report noted that the rupee has weakened more than 6% since the Iran war began, with higher oil prices increasing pressure on India’s import bill and external balances.

On Wednesday, the currency fell to another all-time low of 96.96 against the US dollar, marking its latest consecutive record low.

The RBI has been selling dollars at an estimated pace of $1 billion per day in recent trading sessions to curb excessive depreciation in the currency.

Bond market reacts positively

Market participants said the swap announcement is likely to support bond markets by ensuring liquidity conditions remain comfortable.

“The swap will be good for bonds as it will help maintain surplus liquidity,” said Alok Singh, head of treasury at CSB Bank, as cited in a Reuters report.

Singh added that the move could also ease pressure in currency forward markets.

"It should cool forward, which has been rising over the past two weeks, and bring down hedging costs.

The impact on the INR spot rate is likely to be neutral," Singh said.

India’s benchmark 6.48% 2035 bond yield declined following the RBI announcement.

The yield fell 3.4 basis points to close at 7.0761% on Wednesday, reflecting improved sentiment in the debt market after the liquidity-supportive measure.