==Main Note - [USDINR Sell/Buy Swap](Forex%20Swaps.md#USDINR%20Sell/Buy%20Swap) in ==Foreign Exchange (Forex) Swaps 1. On [Mar 12, 2020](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=49501), RBI announced a Sell/Buy Swap to provide US dollar liquidity of $2 billion to banks. So, let’s try to know what’s a swap, why is the RBI doing it, and how will it impact the rupee. 2. A bank usually sources dollars for its clients from the interbank market. In India, oil-marketing companies are the biggest buyer of dollars. But, in times of sell-off in financial markets, the demand for foreign exchange from FPIs (foreign portfolio investors) can be a swift one. This creates shortage of dollars in the inter-bank and leads to increased weakness in rupee, to a level which could make RBI uncomfortable. 3. With rupee near the life-time lows of 74.38 seen in October 2018, RBI decided to intervene and announced a Sell/Buy swap to directly provide foreign exchange to banks. 4. A swap has two legs or two transactions. The time period between the two transactions is the tenor of the swap. In the first leg on March 16, 2020, RBI would sell/ provide US dollars to the banks (thereby increase dollar liquidity in the forex market) and in return absorb rupee liquidity . The second leg on September 18, 2020, involves banks return dollars to RBI and RBI injects rupee liquidity back into the banking system. Tenor of this swap will be 6 months. 5. Banks bid the forward premium (forward points) they want from the RBI. Premium = difference between spot rate and future (forward) rate, decided through auction (not fixed by RBI). Because of this premium, RBI will give back more rupees in the second leg than it took in the first leg. Premium exists because interest rate of India (₹) is higher than the US ($) interest rate. 1. RBI would give dollars to qualifying banks at the reference rate, which prevails on the day of the auction. 2. Reference rate is published by FBIL. 3. The actual exchange of dollars would take place two days later as it would be a settlement on “spot-basis”. RBI would credit dollars in the nostro accounts of the bank held with their correspondent banks and debit the current accounts that banks (excess reserves) maintain with RBI. Banks would provide the details of the nostro accounts to RBI’s back-office. 4. A nostro account refers to a foreign-currency account that a bank holds in another bank overseas. 5. With dollars already in hand, the demand for dollars in the interbank market would reduce and arrest weakness in rupee, at least for sometime. 6. In the second leg, banks would return the dollars and receive rupees equal to the spot \+ cut-off premium decided at the day of auction. 7. To be sure of the price at which they would buy dollars to return it to RBI, banks would enter into 6-months forward contracts and can influence forward premium depending on market positioning. It has been seen that as the dollar rises versus rupee like the present scenario, exporters try to withhold (not convert) dollars in their EEFC accounts expecting better value for their dollar funds. This leads to further shortage of dollars in the interbank market. With expected fall in spot rates but higher forward premium, exporters may start to sell dollars and importers may postpone dollar purchases, further controlling the volatility in rupee. 8. In the following period, if the asian currencies remain weak and a sell-off in local stocks by FPIs persists, then the move by RBI may not be sufficient enough to arrest the fall in Rupee. ## References ### [Press Releases & Notifications](https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx) 1. RBI. (Mar 12, 2020). ==RBI Announces USD/INR Sell Buy Swaps==. [Link](https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=49501) [More References](Forex%20Swaps.md#References)