RBI may turn to longer buy-sell swaps amid rising $ short positions

More changes likely in liquidity management framework

With dollar short positions rising in the non-deliverable forwards (NDF) market, the Reserve Bank of India (RBI) could introduce longer-tenure buy-sell dollar-rupee swaps to address the current liquidity situation, according to market participants. Currently, the RBI is conducting short-term swaps scheduled to mature in May, June, and November of this year.

 

The RBI’s net short position in the forward market climbed to $58.9 billion by the end of November, up from $49.18 billion in October, showed the latest data.

 

“In a smart move, the RBI has started to sell in the spot and NDF (markets) and then doing short-term buy-sell swaps to replace the maturing forward sale position and also to counter the durable liquidity drain from spot intervention,” stated Soumya Kanti Ghosh, group chief economic adviser at State Bank of India, in a report.  

 

“We also think the RBI may announce longer term (2-3 years) buy-sell swaps to shore up reserves and release liquidity,” Ghosh said.

 

India’s foreign exchange reserves declined for the sixth consecutive week, reaching $625.9 billion for the week ended January 10 — a 10-month low. This marks a drop of nearly $80 billion from the all-time high of $705 billion in late September. The RBI has been actively intervening in the foreign exchange market as the rupee came under pressure in recent months. 

 

Liquidity in the banking system has tightened due to foreign exchange market interventions, fluctuations in government cash flows, and factors such as currency leakage. As of last Friday, the liquidity deficit stood at Rs 1.94 trillion.

 

To tackle the situation, the RBI has been conducting daily overnight variable rate repo (VRR) auctions. Though VRR auctions are meant to meet short-term liquidity needs, these are increasingly being used to address persistent liquidity challenges.

 

To address these challenges, the RBI has taken a strategic approach by selling in the spot and NDF forward markets and carrying out short-term buy-sell swaps.

 

Experts have called for a more durable approach to liquidity management. “Core liquidity is currently in a deficit of Rs 0.6 trillion, which could widen to Rs 2.5 trillion by the end of March. What we require is better assessment of the evolution of liquidity,” said Gaura Sen Gupta, chief economist at IDFC FIRST Bank. “Along with other instruments, the RBI should conduct longer tenure swaps,” she added.

 

The RBI’s move to introduce daily VRRs to address liquidity concerns has triggered speculation that the central bank may relook at its existing liquidity framework. More changes in the liquidity management framework is likely. “They (the RBI) have already implemented daily VRRs and assured VRRs, which somewhat contradicts their existing liquidity framework. It’s possible they may reconsider it, as the current approach to managing liquidity may not be in line with their intended strategy,” said a senior executive at a primary dealership.