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The USD/INR buy-sell swaps conducted by the Reserve Bank of India (RBI) to inject durable liquidity into the banking system have led to a decline in forward premia on USD/INR contracts, reducing hedging costs for Indian corporates seeking to borrow from overseas markets.
RBI’s buy-sell swap strategy is incentivizing corporates to raise funds abroad, which will bring incremental capital inflows and help bolster India’s foreign exchange (forex) reserves. These reserves have been gradually declining as the RBI has been intervening in the forex market to curb rupee volatility.
“When the RBI conducts buy-sell swaps, forward premia decline, reducing swap costs for Indian corporates that are borrowing overseas. As a result, the overall borrowing cost for corporates decreases, encouraging more overseas borrowing,” said the treasury head at a private sector bank.
The dollar-rupee 1-year forward premium eased to 2.13 per cent on Friday from this year’s high of 2.71 per cent in early January.
“With buy-sell swaps, the RBI has not only injected liquidity into the system, it is also trying to encourage Indian corporates to borrow overseas, which will boost capital inflows into the country, increasing foreign exchange reserves. Indirectly, these swaps help strengthen the reserves,” he added.
The RBI has conducted USD/INR buy-sell swap of $15 billion so far and announced another $10 billion of buy-sell swap. These measures are part of the central bank’s broader measure to infuse durable liquidity into the banking system, which has been in deficit for the past 11 consecutive weeks.
“The RBI has conducted USD/INR buy-sell swaps worth $15 billion, leading to a decline in forward premia. The objective is to extend maturities in the forward book, as the RBI holds net short positions of $77.5 billion, with a significant portion maturing within three months,” said Gaura Sen Gutpa, chief economist, IDFC First Bank, adding that to make these maturities more manageable, the central bank is conducting these swaps, which are inadvertently lowering hedging costs for Indian corporates.
“Additionally, the RBI has room to conduct another $10 billion-$20 billion in swaps, which could further reduce hedging costs,” she added.
Indian corporates, particularly non-banking financial companies (NBFCs), have been increasingly tapping overseas markets for funding, especially after the RBI raised risk weights on bank lending to NBFCs in November 2023. This move was aimed at encouraging NBFCs to diversify their funding sources.
Recently, IIFL Finance raised $325 million through the issuance of international bonds with a three-and-a-half-year tenor at a coupon rate of 8.75 per cent. Additionally, Tata Capital, the financial services arm of the Tata group, raised $400 million through its maiden international bond.
“The RBI's primary objective with these swaps is to inject liquidity into the system. However, they have also contributed to lowering forward premia, thereby reducing hedging costs. While this will likely encourage Indian corporates to borrow overseas, their decisions will also depend on confidence in the RBI’s commitment to continuing such swaps for liquidity management,” said Madan Sabnavis, chief economist, Bank of Baroda.
During April-December 2024, the share of effectively hedged external commercial borrowing — explicitly hedged loans, rupee-denominated loans, and loans from foreign parents — increased to 78.1 per cent from 61.6 per cent over the same period of the previous year, according to RBI data. This has helped in offsetting the interest and exchange rate sensitivity of such exposures.
