India expects $80 billion from forex swap schemes: What does it mean for India’s reserves?

India could see at least $80 billion in foreign currency inflows through three special forex swap schemes launched by the Reserve Bank of India (RBI) in June, Governor Sanjay Malhotra told The Financial Express.

The central bank has already attracted more than $56 billion through the schemes, with the response stronger than expected. Malhotra said the final inflows from all three facilities could reach at least $80 billion.

“This reflects the strong macroeconomic fundamentals of our country and would also further strengthen our balance of payments,” Malhotra told The Financial Express.

The comments come days after the RBI decided to close one of the three schemes earlier than planned. The decision to advance the closing date of the special swap facility for Foreign Currency Non-Resident (Bank), or FCNR(B), deposits reflects the central bank’s assessment that it has already attracted a substantial amount of foreign currency.

What are the three forex swap schemes?

The RBI introduced three concessional forex swap facilities in June to encourage foreign currency inflows into India and strengthen the country’s balance of payments.

The measures covered FCNR(B) deposits, external commercial borrowings (ECBs) and overseas foreign currency borrowings (OFCBs).

Under the FCNR(B) facility, banks could raise foreign currency deposits from non-resident Indians and use the RBI’s concessional dollar-rupee swap facility to hedge the currency risk.

The response was particularly strong from NRIs. As of August 13, banks had mobilised $52.3 billion through FCNR(B) deposits. Including the other two facilities, total inflows had reached about $56.85 billion, according to RBI data.

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The RBI now expects the three schemes together to generate at least $80 billion.

Why are these inflows important for India?

The immediate significance is that they strengthen India’s external financial cushion.

Foreign exchange reserves act as a buffer against external shocks. They help the RBI manage sudden movements in the rupee, meet the country’s external payment requirements and deal with periods of weak capital inflows.

India’s forex reserves rose to about $707 billion in the week ended August 7, their highest level in the current financial year. Reserves jumped $14.1 billion in a week, with foreign currency assets accounting for much of the increase.

The recent rise has come as policy-driven dollar inflows have accelerated.

Reuters reported that India’s reserves had increased by around $40 billion over six weeks, helped by measures including the RBI’s forex swap facilities.

For the RBI, the additional dollars provide greater room to deal with volatility in the currency market without having to rely solely on its existing reserves.

Does $80 billion mean reserves will rise by $80 billion?

Not necessarily. The $80-billion figure is the RBI governor’s estimate of total inflows expected through the three swap schemes. It should not be treated as a direct $80-billion addition to the RBI’s headline foreign exchange reserves.

Forex swaps involve the exchange of currencies and create corresponding liabilities and assets on the central bank’s balance sheet. The impact on reserves therefore depends on how the transactions and other external flows affect the RBI’s foreign currency assets and liabilities.

The more important point is that the schemes have brought a large amount of foreign currency into the Indian financial system at a time when the RBI wanted to strengthen the balance of payments.

Why did the RBI close the FCNR(B) facility early?

The strong inflows are also behind the RBI’s decision to shorten the FCNR(B) window.

The facility was originally scheduled to accept fresh deposits until September 30. The RBI has now advanced the deadline to August 31.

Banks can continue to execute swaps with the central bank against eligible deposits until September 11.

The other two facilities — for ECBs and overseas foreign currency borrowings — will remain available until the end of December as originally planned.

Malhotra told The Financial Express that the decision was “well-thought-out, calibrated, prudent and data-driven”.

He also rejected the idea that the early closure represented a reversal in policy.

The decision, he said, was taken from a “position of strength”, as flows had been stronger than both the RBI and most market participants had expected.

What does this mean for the rupee?

A stronger supply of dollars can help reduce pressure on the rupee, particularly when demand for foreign currency is high.

The RBI, however, has repeatedly said that it does not target a particular exchange-rate level.

Malhotra told The Financial Express that the rupee remains market-determined. He said the RBI’s intervention policy is aimed at curbing excessive volatility and undue speculative activity.

The central bank is not necessarily trying to push the rupee to a particular level. Instead, a larger pool of foreign currency gives it more flexibility to smooth sharp movements in the exchange rate.

A bigger buffer against external shocks

The RBI’s move comes against a backdrop of heightened global uncertainty, including swings in crude oil prices and geopolitical tensions.

India is particularly sensitive to oil prices because it imports most of its crude oil requirements. A sustained rise in oil prices can increase the country’s dollar demand and widen the trade deficit.

A large inflow of foreign currency can partly offset such pressures.

The latest swap programme has already helped shift the external picture. Reuters reported that analysts now expect India’s balance of payments position to be stronger than previously anticipated, with the policy-driven inflows helping offset some of the risks from higher oil prices.

What happens next?

The RBI’s decision to close the FCNR(B) window early suggests that the central bank believes the programme has largely achieved its immediate objective.

But the $80 billion expected inflow will not eliminate all external risks.

The rupee will continue to be influenced by crude oil prices, foreign investment flows, US interest rates, global risk sentiment and India’s trade balance.

For now, however, the RBI has gained something valuable: a larger foreign currency cushion.

And with the governor saying the schemes could attract at least $80 billion in total, the June measures have turned out to be far more successful than initially expected.