Forex swap rakes in over $136 bn

Why in the News

Foreign exchange inflows under the Reserve Bank of India’s (RBI) special swap facility have crossed $136 billion, surpassing all projections. The facility was introduced on 8 June this year to deal with forex outflows caused by high oil prices and by the exit of Foreign Portfolio Investors from the stock market. The task has now shifted from raising dollars to managing what they release. Every dollar brought in creates rupee liquidity in the banking system, and the RBI has already begun absorbing it to stop call rates falling below the policy rate.

What is the RBI’s special USD-INR swap facility?

1. What it does: The facility lets a bank exchange dollars raised abroad for rupees with the RBI at a concessional rate, with a commitment to reverse the exchange at a future date.
2. What it covers: It applies to three instruments, Foreign Currency Non-Resident (Bank) or FCNR(B) deposits, Overseas Foreign Currency Borrowings (OFCBs), and External Commercial Borrowings (ECBs).
3. Why it was opened: It was designed to attract fresh foreign currency at a time when the rupee and India’s reserves were under pressure from oil prices and portfolio outflows.

Where did the $136 billion come from?

1. The total mobilised: A total of $1,36,377 million has been mobilised, according to data released by the RBI.
2. FCNR(B) deposits dominate: Deposits by overseas Indians accounted for $1,27,226 million, the overwhelming share of the mobilisation.
3. Corporate borrowing contributed little: OFCBs brought in $5,260 million and ECBs a further $3,891 million.

Why does the RBI’s short forward dollar position matter now?

1. What a short forward position is: Short forward dollars are currency derivative contracts in which the RBI commits to sell dollars at a future date at a predetermined rate.
2. Why the RBI built one: The instrument defends the rupee without drawing down spot reserves immediately, so the headline reserve figure holds while the commitment sits in the forward book.
3. The size of the book: The RBI carries an outstanding short forward position of $137 billion, close to the entire mobilisation under the swap facility.
4. How the two connect: If the RBI decides not to roll over those positions, it may use the excess reserves generated from the FCNR(B) scheme to deliver the dollars it has contracted to sell.

What does the inflow do to domestic liquidity?

1. Rupees enter as dollars arrive: Delivering on the forward book absorbs rupee liquidity from the banking system, which is why the RBI has begun draining it before call rates slip under the policy rate.
2. The surplus is large: Banking system liquidity stood at Rs 6.5 lakh crore, and the RBI may absorb part of it so short term money supply does not feed into inflation and borrowing costs stay aligned with the policy rate.
3. Banks gain a cheap funding base: In the immediate term banks are inclined to use the inflow to strengthen their asset side books and cut their dependence on wholesale deposits.
4. The longer use is credit: Over a longer horizon the same liquidity can be deployed to fund credit growth.

Conclusion

The facility has done more than it was designed to do, and the constraint has moved from the external account to the domestic money market. The decision that now matters is whether the central bank rolls its forward commitments over or lets them run off against the deposits it has raised. Rolling over keeps the liquidity in the system; delivering drains it. That choice, and the pace at which it is made, is what will determine short term rates over the coming quarter.

Back2Basics: External Commercial Borrowings

1. What they are: ECBs are loans raised by eligible Indian entities from recognised non resident lenders, denominated in foreign currency or in rupees.
2. Forms they take: They cover bank loans, buyers’ and suppliers’ credit, and instruments such as foreign currency convertible bonds.
3. How they are regulated: The RBI governs them under the Foreign Exchange Management Act, 1999, through the automatic route up to prescribed limits and the approval route beyond them.
4. What the framework controls: The rules set the minimum average maturity, the all in cost ceiling and the end uses for which the borrowed money may be applied.

Matching Previous Year Question

“[2022] With reference to the Indian economy, consider the following statements : 1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. 2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness. 3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER. Which of the above statements are correct ? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 ANSWER: (c)”