Big Lenders Urge RBI to Use FX Swaps Amid Surge in Currency Financing Costs

Several major lenders in India have requested the Reserve Bank of India (RBI) to consider injecting liquidity into the financial system using foreign-exchange (FX) swaps. This comes as short-term currency borrowing costs have surged to a four-year high. In recent informal discussions, the lenders suggested that FX swaps could provide much-needed liquidity by enabling the central bank to inject rupees into the market while bolstering its foreign-exchange reserves.

The spike in borrowing costs follows a combination of seasonal factors and an increase in global investors’ demand for the rupee, which a surge in local initial public offerings has driven. Additionally, banks have been hesitant to part with rupees due to low liquidity, intensifying the funding squeeze. The increased borrowing costs pose a challenge for the RBI, which is already grappling with a slowdown in manufacturing activities. While it remains uncertain whether the RBI will approve the lenders’ requests, the side effects of such an operation could put additional pressure on the rupee, which has recently set new record lows.

The RBI’s use of FX swaps would involve purchasing dollars from banks in exchange for rupees, agreeing to reverse the transaction at a future date. This would help alleviate funding costs while simultaneously strengthening the central bank’s foreign-exchange reserves, which have fallen to a seven-month low. The last time the RBI used such a long-term swap was in April 2019, when it swapped $5 billion for a three-year tenure.

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