(Sept 9): India’s central bank used currency swaps to drain cash from banks, according to people familiar with the matter, as excess funds in the financial system climbed to a record.

The Reserve Bank of India carried out short-term sell-buy foreign-exchange swaps in the market, some of which mature in October, the people said, declining to be identified as the information is private. They did not elaborate on the size of the deal.

Under the transactions, the RBI sells dollars to banks for rupees and agrees to buy the US currency back later. This reduces rupee liquidity from the banking system, which surged to around 11 trillion rupees (RM470 billion) following massive inflows under the RBI’s recent capital-raising plans.

A spokesperson for the RBI did not immediately respond to an email seeking comment on the matter.

Three-month dollar-rupee onshore forward yields rose 23 basis points to 3% on Wednesday, while six-month yields were up 15 basis points.

The massive cash surplus has pushed down banks’ funding costs, posing a challenge for the RBI as cheaper borrowing could add to inflation risks. Bond and currency traders have been on the lookout for RBI steps to tackle the surplus, with the central bank stepping up temporary cash withdrawals.

“Sell/buy swaps can push the liquidity problem into the future, but not eliminate it,” said Madhavi Arora, economist with Emkay Global Financial Services. “The RBI could use six to 12-month swaps to sterilise a large liquidity injection without immediately tapping domestic bond market instruments.”

Large auctions, however, could put upward pressure on forward premia if the market struggles to absorb the flows, intensifying hedging costs and potentially raising RBI’s cost when the swaps are rolled over, Arora said.

Uploaded by Arion Yeow