India central bank likely deploys FX swaps to mop up overseas deposit-driven liquidity, traders say

MUMBAI: The Reserve Bank of India is likely conducted near-maturity dollar/rupee sell-buy swaps, as part of its recent efforts to absorb surplus rupee liquidity stemming from overseas deposits raised by lenders, seven bankers said.

The central bank is conducting the swaps with a maturity in September, four of the bankers and two FX brokers said, while two of the banker sources also said it was likely doing so for October maturity as well.

Forward premiums for September and October rose about 2.5 paisa and 4 paisa, respectively, in response, lifting premiums across tenors, according to the traders.

The bankers, traders and brokers requested anonymity as they are not authorised to speak to the media. The RBI did not immediately respond to an email seeking comment.

In a swap, the RBI sells dollars at the spot rate in exchange for rupees, effectively sucking liquidity out of the banking system. The transaction is reversed at maturity, which in this instance would be either September or October.

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Three other bankers estimated that the central bank had conducted swaps worth at least about $1 billion across the two maturities. Indian lenders had proposed using FX sell-buy swaps for liquidity management at a recent meeting with the RBI.

The RBI’s move on Wednesday comes after its 30-day variable-rate reverse repo (VRRR) operation drew a weak response earlier this week.

Liquidity glut

The banking system is saturated with rupee liquidity following a surge in dollar deposits raised by lenders from non-resident Indians and swapped with the RBI for rupees at zero cost.

Gaura Sen Gupta, chief economist at IDFC FIRST Bank, estimated that core liquidity surplus has peaked at 14 trillion rupees to 15 trillion rupees ($147.26 billion-$157.78 billion).

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The RBI will aim to drain about 7 trillion rupees using VRRR operations and more durable instruments, she said, adding that sell-buy swaps are likely to be among the RBI’s preferred options.

Banks have raised about $128 billion through non-resident deposits, far exceeding initial expectations.

“The RBI had to look at ways to manage the liquidity overhang and it looks like, for now, it has decided to use swaps, which buys it time for a few weeks,” a senior treasury official at a mid-sized private sector bank said.

Another benefit of sell-buy swaps is that they can help the RBI trim the size of its FX forward book, he added.

The central bank’s net forward dollar liabilities stood at about $137 billion at the end of July with $47.6 billion in the up to one year bucket.