The RBI uses the dollar-to-rupee swap auction as a mechanism to inject or suck out cash into the economy and control currency pressure. It runs on a conversion between the US dollar and the Rupee. Under this mechanism, banks shall buy USD from the RBI against the INR, RBI shall give USD to the banks. This mechanism draws dollars out of the financial system while siphoning in Indian Rupees, and the opposite occurs in a sell/buy swap. A $5 billion two-year sell/buy swap auction has been announced by the RBI. The auction date set was March 8, and the spot date, or the day on which the deal must be settled, is March 10. The RBI plans to sell $5 billion on this day to the banks which have submitted the lowest currency premium bid. With the lowest premium possible for the two-year tenor, the goal is for the central bank to buy dollars from the seller. As a result, banks that placed bids in the lower range of the auction win the bid. The RBI will have two years to repurchase these funds. RBI is attempting to improve the liquidity of USD in the market as there is a mismatch. In a limited way, forex swaps help to manage liquidity and control exchange rates. The economy may be negatively affected when the central bank uses conventional methods like raising the repo rate or the CRR. So, RBI employed a different toolset known as variable rate reverse repo auction (VRRR) in the previous year. However, banks underwrote the auction because the cash market offered instantaneous and superior rates, thus forcing RBI to go for a longer-term liquidity adjustment tool like forex auctions. According to RBI, the reason for the swaps was the "extreme risk aversion due to the spread of COVID-19 infections" and the "strong selling pressure" seen globally. The decrease in bond yields in advanced economies and the slump in global petroleum prices have escalated this. RBI may profit or face a loss from this swap auction, but based on prior years, when the cut-off premium for bids was in range of ₹8.40– ₹8.45, profits from the auctions may reach to the tune of ₹8,400 crores. Every asset class is seeing an increase in volatility, and these imbalances put more pressure on the central bank to maintain the economy and protect the status quo. Thank you.
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