Dollar swap to help RBI in balance sheet management, besides cooling forex market (2024)

The Reserve Bank of India’s $5 billion two-year sell/buy swap would help the central bank marginally reduce the size of its balance sheet, improve its dividend-paying capacity, and help manage liquidity and currency positions better, said analysts.

Since the RBI’s economic capital requirement as per the Bimal Jalan committee is linked to the size of assets, any reduction in the balance sheet reduces the need for economic capital, or the resources required to be set aside against possible risks.

The central bank faces an uphill task of meeting the dividend expectations this fiscal year as it needs its revaluation reserves to rise by about Rs 1 lakh crore to meet the capital norms prescribed by the Jalan Committee.

RBI had paid Rs 99,122 crore dividend to the government for July 2020-March 2021 period.

"Even as the RBI will decry any attempt to connect its market operations with any dividend outcome, the mathematical connect cannot be wished away, and unhealthy speculation among some market participants will likely persist," said Ananth Narayan, senior India analyst at the Observatory Group, a research firm. “Since the RBI economic capital requirement as per the Jalan committee is linked to the size of assets, any reduction in the balance sheet reduces the need for economic capital. The swap would reduce its balance sheet by that amount. This, in turn, would release economic capital of 20.8% of that amount, or about $1 billion.’’

The Bimal Jalan Committee that looked into the RBI’s economic capital had made two key recommendations: the central bank should hold realised equity of between 5.5% and 6.5% of its assets, and, it should hold economic capital — across realized equity and revaluation reserves — of between 20.8% and 25.4% of its assets. With the central bank’s active intervention in the market to cool the government bond yields and currency market actions, the RBI’s balance sheet has expanded by about Rs 6 lakh crore through the course of FY22 to date, necessitating an increase in the economic capital of around Rs 1 lakh crore.

The swap may help, but not much.

“But we should remember this may not add much to the kitty considering that throughout the year the system was in surplus of Rs 6-7 lakh crore at the reverse repo window which would have cost RBI Rs 20,000-24,000 crore’,’ said Bank of Baroda chief economist Madan Sabnavis. ‘’Hence this accrual will compensate for this higher expense of the central bank.’’

The need to provide for economic capital under the Jalan committee framework would be lessened by around Rs 37,000 crore from this transaction, estimates Rahul Bajoria of Barclays. This in turn could help release about Rs 4,000 crore towards dividend payment to the government.

Besides a smaller balance sheet, a weaker rupee would also enhance currency revaluation reserves and economic capital and hence allow for a higher dividend payment to the government. For every 1% weakening of the local currency, RBI could enhance its dividend payment by Rs 35,000 crore, if everything else remains unchanged, Narayan said.

Announcing the sell-buy swap, the RBI said that it would elongate the maturity profile of its forward book and smoothen the receivables relating to forwarding assets.

The swap operations would also help manage the domestic market liquidity that has been in surplus at more than Rs 9 lakh crore and prepare for a surge in inflows of dollars when the initial public offering of LIC hits the market in March.

“The first leg of the swap, RBI will sell dollars and drain rupee liquidity. This will create space for RBI to soak up dollar inflows,” said Gaura Sen Gupta, an economist at IDFC First Bank. “This (excess liquidity) prevents RBI from conducting outright OMO purchases as it would infuse more liquidity. The sell-buy swap solves this issue by draining rupee liquidity, creating space for RBI to conduct outright OMO purchase.”

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