MyWay Wealth Weekly Update (Issue #22): Here’s how RBI is trying to kill two (or more) birds with a single stone!

“There is always the potential for a central bank to engage in discretionary monetary policy and to break the one-to-one link between changes in foreign reserves and changes in the money supply.”- Steve Hanke (American Economist)

Late evening, this Wednesday, RBI announced that it would conduct a USD/INR swap auction for $5 billion. We view this as an exceptionally well-thought implementation by RBI to infuse liquidity and manage INR rates with a single move.

How does the swap work?

Eligible banks will bid a premium (an additional amount they are willing to pay RBI) to avail the opportunity to exchange their US Dollar reserve for a Rupee equivalent from RBI. This swap allows the bank to utilise the INR for banking activities and are expected to return this INR amount to RBI along with the committed premium at the end of three years to get their USD reserves back.

How does this help India?

While the benefits are multi-faceted, here are the two key impacts of such an action:

  • Infusing liquidity in the system:Infusing liquidity in the system has been on the top cards for RBI.In line with this objective, RBI has already purchased ~74% of the government’s net bonds issued which has resulted in an infusion of ~ INR 2.8 lakh crores in FY 2018-19. With this being the season for tax outflow and the current liquidity shortfall is ~INR 48,000 crores, the deficit is expected to surpass INR 2 lakh crore (stats per Bloomberg) making liquidity-infusing measures even more important.This swap will play a key role in leaving banks with more liquid INR to circulate in the economy.
  • Dampening the expected spike in INR value: The Indian economy is expecting a strong stream of foreign cash flows which can be expected to result in a sudden appreciation of the INR.  Key sources of foreign flow could be from the strengthening inflows by FPIs into Indian equities along with a few big corporate actions including ArcelorMittal’s ~$6 bn bid for Essar steel and a few other private equity deals in the pipeline.Another major reason to dampen the appreciation is to protect the export economy which is expected to play a major role in pushing economic growth in the time to come.

What should a fixed-income investor do?

While we have been expecting a rate cut since some time now, this swap auction along with significant bond buyback by RBI (~ INR 2.8 lakh crore) this fiscal year eliminates the need for a rate cut to a good extent. But, the fresh spurt in liquidity may bring along some demand-led softening of yields.

Short to medium term papers with AAA/sovereign-rated quality seem to be the sweet spot right now. It is still advisable to stay away from longer maturity debt funds.

While RBI made an unprecedented announcement, the week also witnessed strong resilience by Indian equities:

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If you have any concern, please write to us at ask@mywaywealth.com or call at 080 48039999we would be happy to answer your query.

Thanks,
Nirav (Head of Research)
MyWay Wealth

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