Reserve Bank of India (RBI) suddenly announced in the late evening of 16th March, 2019 that it will hold a 5 billion dollar 3 years buy/sell swap auction on 26th March, 2019. Students of banking who are just initiated into learning foreign exchange are asking questions as to what is this, why is this happening and what would be its effect on the markets. After all, such actions by the RBI are not that common. The last time this route was used by RBI was six years ago, in 2013.
Life for human beings was very simple several decades ago. Happenings in far away lands never disturbed our lives. Economics was the exclusive domain of economists. Politics was confined to a handful of rulers or members of the ruling class. Wants were limited. Villages were like self-sufficient units. Life was carried on with whatever is available. Food and shelter were the basic needs. Even a small hut was taking care of the shelter need. It is not so any longer. Everyday events disturb the equilibrium of our life. Things are fine when we go to bed in the night. Some overnight event in a far away land shakes the equilibrium and a new balance has to be found on the next day. Many things are not in our control. Some of the things are not in the control of even the policy makers. Life has become like an air-filled balloon. If it is pressed at one place, it bulges elsewhere. Economics and Politics affect our daily lives. We cannot escape these influences even if we so desire.
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Election Commission of India has announced general elections to the 17th Lok Sabha to be held next month. The process takes one and a half months to be completed. Elections are called as the festival of democracy which is indeed true. But elections means campaigning, voting and counting. For the common man, the festival ends with counting. Thereafter it is a long festival for those who are elected for the next five years. It is one day festival for the voter and 4 years 364 days for those who win. Elections also means breaking old friendships and forging new alliances for the politicians. Elections are preceded by high decibel campaigning. Thanks to the efforts of successive Election Commissioners, the sound of the campaigning has somewhat come down. But the heat of campaigning continues to be the same. It can even be said that the heat is going up due to the ever pervasive electronic media.
Election campaigning means spending a lot of money. The Government and Election Commission spend considerable amounts to handle the process. Candidates and political parties also spend heavily. There is an official limit for the expenditure by a candidate during an election. The limit for an assembly candidate in the last Telangana election was 28 lakh rupees. The Election Commission has fixed a limit of 70 lakh rupees per candidate during the next Lok Sabha elections. However, there is no limit for the expenditure incurred by the political parties. Efforts of the Election Commission to cap this expenditure is resisted by political parties. In a way, these expenditure incurred by the candidates and political parties is welcome to many people. Elections provides temporary employment to workers who indulge in door-to-door campaigning and acting as polling booth agents etc. Lot of money hoarded in black and dark boxes finds its way into the market. Printing presses and transport operators work overtime. Many other allied economic activity also picks up during elections.
The amount of money spent during an election makes astounding numbers indeed. The election to US President and Congress in 2016 cost 6.5 billion US dollars. This is equivalent to 45,500 crore rupees at an exchange rate of 70 rupees per dollar. General elections to Lok Sabha in 2014 was estimated to have cost 35,000 crore rupees. The estimates of expenditure for the next months election is around 50,000 cores (about 7 billion US dollars). PTI reports that Milan Vaishnav, Senior Fellow and Director of The South Asia Program at Carnegie Endowment for International Peace feels that it may even cross 10 billion US dollars, which would be 70,000 crore rupees. This is more than twice the amount spent by our central government per year on education including technical education.
Thus there is a need of enhancing the current level of liquidity in the market to meet this staggering requirement of funds. The funds spent thus now will no doubt come back into the pool, but that will be a time lag. That is another problem to be faced later.
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There was a cry about shortage of liquidity in the market during the last few months. It was felt that NBFCs were facing liquidity crisis. Various actions resulted in some of the banks placed on Prompt Corrective Action (PCA) by RBI coming out of the cage and becoming free to lend further. IBC led recovery process has kindled the hopes of banking units returning to better health. The sudden burst of hostility in the borders created tensions in the markets, but the temporary truce has brought cheer to various segments of the markets. Forecasts of formation of a stable government after next elections has been received enthusiastically by the markets, though doubts on this front have not completely vanished. Demand for credit is picking up and there is a demand for higher liquidity for these reasons as well. Year end advance tax payments and other requirements also cry for liquidity support.
To address these concerns, RBI has pumped more than 50,000 crore rupees into the market through Open Market Operations (OMO) during the last two months. OMO is resorted to RBI to pump funds or withdraw funds to and from the market by either buying securities and releasing funds or sucking surplus funds by selling securities.
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There was a hue and cry six months ago about petrol and diesel prices. The all-time high prices called for drastic actions. Hardening international oil prices coupled with weakening of the rupee led this price surge. There were also some peculiar instances of token reduction in taxes on petrol and diesel by some governments. Dollar-rupee rate ran up to 74 rupees per dollar in October, 2018. There were reports about newly wed couple being presented with petrol cans as gifts. Economic astrologers belonging to opposition parties predicted that the day when a dollar would cost 100 rupees was not far off. Changes in the international scene on oil front coupled with increasing foreign investor confidence in Indian markets reversed the trend. On 8th February, 2019 one US dollar cost 71.55 rupees. Two days ago (15th March) it came down to 68.96. Heavy inflows of foreign funds into stock and bond markets pushed up the Sensex to record levels. 
One man's meat is another man's poison, they say. Importers were crying when dollar prices went up to 74 rupees, but exporters were happy. Each dollar of exports was getting them five to six rupees more last October. Indian exporters for many items have to face stiff competition in international markets from exporters of neighbouring countries like Bangladesh, Sri Lanka, Pakistan, Malaysia, Jordon and others. Government supports these exporters through various schemes like refund of excise and custom duties paid by them (duty drawback) and cash incentives. These incentives are small when compared to a six rupee increase per dollar of export earning. As the dollar rate dipped to sub-70 levels exporters came under pressure. Overall exports contracted during the last quarter for many reasons, exchange rate being one of them. There was an immediate need to protect exports now.
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RBI does not target any particular exchange rate level for the rupee. However, one of its main objectives is to ensure stability in the exchange markets and prevent excessive volatility. The fall in Dollar-Rupee rate from October to now is 7.25%. In the last 5 weeks alone (8th February to 15th March, 2019) it has fallen by 3.76%.
Higher inflows of Dollars has resulted in excess supply leading to fall in its value. RBI has many concerns and liquidity as well as stability of exchange rates are among them. Further surge in dollar inflows is expected in the coming weeks due to perceived succession by a stable government after elections and softening of cross border tensions. Liquidity is like blood pressure. High blood pressure is dangerous. Low blood pressure is even more dangerous. Same goes for volatility in exchange market price levels. Dollar at 74 rupees was worrisome; same at 68 as well. RBI has to manage both liquidity as well as stability in exchange markets.
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Can it kill two birds with one stone? The sudden announcement of Dollar-Rupee swap is one such action by the regulator. The swap comprises buying spot dollars and selling three years forward dollars. For a common man, spot means here and now. But in exchange and security markets, due to time difference across the globe as well as other reasons, date of entering into a transaction and actual delivery can be different. What is a swap? A swap is simultaneous purchase and sale of the same item, but for different maturities. Item purchased and sold is the same but delivery dates differ. RBI plans to purchase 5 billion US Dollars now and sell the same three years later. Three years is a long time in the exchange market time line. This swap will result in increasing foreign exchange reserves by 5 billion dollars. At the same time, 35,000 crore rupees will be pumped into the markets to address liquidity concerns. Both these happen immediately.
This action of RBI is expected to stabilise Dollar-Rupee rate around 70 rupees. It will also bring down OMO by 35,000 crore rupees. Hedging costs for foreign investors is expected to come down encouraging further dollar inflows. There may be some costs for the RBI in this process. But the benefits could be considerable. New problems may arise, but new solutions will be found. The cycle marches on....
This combination of politics, economics, domestic and foreign exchange markets is very interesting. Isn't it?
