The $5 billion rupee-dollar swap window announced by the Reserve Bank of India (RBI) will lead to downward movement in interest rates as injection of higher rupee liquidity will help lower yields on government bonds.
Sources said this will bring down interest costs for high-rated Indian companies raising resources through external commercial borrowings (ECBs), while at the same time making rupee bonds more attractive for foreign investors.
The rub-off effect of this move, along with benign inflation forecast and slowing industrial growth, will nudge the RBI Monetary Policy Committee to cut interest rates further in the policy review next month.
According to participants in the fixed income market, the interest rate swaps which are used to indicate future movements in rates, are pointing towards 25-50 basis points rate reduction in next few months. These swaps are used to hedge interest rate risk by fixed interest rate payments with floating rate ones.
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“It is a very good measure and will inject about Rs 30,000-40,000 crore of rupee liquidity. It is one more instrument besides the OMO (Open Market Operations) to manage liquidity. The rate cut anyways is linked to inflation and growth, which are coming down, so we are expecting reduction in rates in any case,” said Rashesh Shah, chairman and CEO of Edelweiss Group.
“The measure will reduce hedging cost of overseas borrowings, leading to fall in overall reduction in the debt cost and making INR bonds more attractive to foreign investors,” said Amit Tripathi, chief investment officer-fixed income, at Reliance Mutual Fund.
Could nudge MPC to further cut rates during policy review
The $5 billion rupee-dollar swap window is aimed at addressing the liquidity deficit persisting in the markets since last year. It will lead to downward movement in interest rates as injection of higher rupee liquidity will help lower yields on government bonds. While the measure will bring down interest costs for high-rated Indian companies raising resources through external commercial borrowings and make rupee bonds more attractive for the foreign investors, the rub-off effect of the move will be to nudge the RBI Monetary Policy Committee (MPC) to cut interest rates further in the policy review next month.
On Wednesday, the RBI decided to inject rupee liquidity for three years through long-term foreign exchange Buy/Sell swap. Under this, the RBI will buy up to $5 billion from the market via auction on March 26, and simultaneously sell it back to the same counterparties effective March 2022.
Whatever amount of dollars get mopped up via these operations will reflect in the RBI’s foreign exchange reserves for the tenor of the swap while also reflecting in RBI’s forward liabilities. Meanwhile, the system gets rupee equivalent liquidity for the same amount and for the same duration.
While this measure will address the immediate liquidity issue, the market needs a better commentary on what is the liquidity outlook of the central bank, especially since there has been a crunch for last one and a half year, and, said Gagan Banga, vice chairman and managing director, Indiabulls Housing Finance.
“The emphasis of the central bank has to be that liquidity has to be there. If the liquidity is there interest rate cut will automatically happen, even if the repo rate is not cut,” he said.
Industry sources said the RBI is engaging with market players to ensure better rate transmission and ease liquidity crunch.
“Transmission of rate cuts is more important that the rate cut itself, and this (rupee-dollar swap) will lead to better transmission of rates,” Tripathi said.
While inflation remains within RBI’s comfort zone, industrial output is unlikely to pick up in the remaining two months of this financial year, prompting further cuts in policy rates.
Factory output growth slowed to 1.7 per cent in January from 7.5 per cent a year ago, mainly due to weak manufacturing and electricity output. However, retail inflation, based on Consumer Price Index, increased to a four-month high of 2.57 per cent in February.
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