Useful tool (Dollar - rupee swap by RBI - 2019)

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 Useful tool (Dollar - rupee swap by RBI - 2019)

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• RBI brings a dollar-rupee swap : The Indian economy needs more liquidity (funds flow) to push economic growth, and the RBI can help a bit. It can -

1. Purchase bonds from open-market  (OMO), or
2. Bring a dollar-rupee swap.

• The RBI has gone for (b), showing a big change in its liquidity management approach. By (a), the bonds markets are impacted, and by (b) the currency markets will be.
• Details of the swap scheme :

1. It is a 3-year swap scheme
2. RBI will buy $5 billion from banks, giving them rupees
3. Target is to infuse upto Rs.35,000 crore into the economy in one shot (in a tight season)

• Impact of the move :

1. The banks will earn some interest on the foreign exchange lying idle with them.
2. The RBI's dollar reserves will go up, and the move will impact the currency markets too.
3. Bond yields went up (after the swap scheme announcement) - it shows that traders feel swaps will be more relied upon in future  (so demand for bonds low, so prices low, so yields high)

• Rupee's rally in 2019 : The INR appreciated rapidly against the dollar (due to many reasons), but this swap scheme in which dollars are sucked OUT and rupees infused IN has halted the rise in INR's value. But overall INR is up since the lows of Oct. 2018 as FPI money is coming in.  (Why?)
• Expansion of toolkit : So RBI has a new tool, with two targets - impact liquidity, and impact currency price. Post the ILFS crisis, that created a liquidity crisis in NBFC, this can be a good way to lower borrowing costs too.
• Election effect : A lot of cash withdrawal happens prior to general elections, and hence RBI may have wanted to boost liquidity in banks.
• What next? What banks get, they need to push into the economy, via lower borrowing rates (for borrowers). If banks simply put the freh RBI money in govt. bonds (low yields), then the govt. does not get punished for its fiscal indiscretion (as the cap on borrowing costs will remain intact). But if banks find new ways to deploy these funds, it'll raise borrowing costs for the govt.
• Summary : The RBI has decided to use a new tool to push liquidity into the banking system - the dollar-rupee swap.

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