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Forex Swaps for Oil Companies Rescues Rupee For Now

The RBI announced forex swaps with oil marketing companies (IOC, BPCL, HPCL). They will take rupees from the oil companies, and give them dollars. The reverse leg will involve the OMCs buying dollars from the market and returning it to the RBI at a certain exchange rate, back for rupees.

For how long is the tenure of the swap? We don’t know.

Typically swaps include the interest rate difference between the two countries and an estimation of the exchange rate. Short term interest rates are 12% now, so a 90 day swap would probably include that, but since the RBI wants to steady the currency it might not include a premium for the rupee depreciation on the outer leg. 

The swap is a derivative. So technically one leg would have been done now, with dollars sold and the rupee bought back. The opposite side will be done later, so it is likely that the RBI decides this doesn’t change reserves, but in reality it does.

Also, like the NSEL fiasco, exposes it to counterparty risk, where the OMC might not be able to pay back in dollars (what if the dollar goes to 80?). But overall this will reduce the pressure on the market.

How much? Estimates are between $12bn and $13 bn per month. That is an equivalent of Rs. 80,000 cr. that will go out of the system per month; money lying within the RBI is out of circulation. Effectively that will contract liquidity in a very big way – even more than all the liquidity measures the RBI has taken on so far.

Impact: Liquidity contraction means even higher short term interest rates. The pressure on the rupee should ease up for a month at least, but foreign investors might still continue to exit, and cause markets to hurt. After a month, this measure is either going to be withdrawn, or if it continues without the oil companies paying RBI back, it will cause a bigger contraction in money supply.

The other impact is about foreign debt. Those that have borrowed from abroad and need to pay back have nearly no easy way of doing so cheaply. Another more deep post on this coming up.

Either ways, short term government debt is currently yielding 12% and I see that as the best way forward (through debt mutual funds). Markets might rebound a couple days, but equities will remain volatile and it’s best to trade rather than take a longer term position.

  • RKG says:

    RBI can do this swap at level rates – and keep rolling it over until such time that market spot rate is lower enough to insulate the oil companies from exchange losses (which is what is likely to happen)
    WHAT is somewhat intriguing is – these swaps will be routed through some PSU banks – the forward contract will attract CAR and how will the PSU handle that aspect.. or maybe RBI has clarified and i am not aware..
    in the realm of unconventional policies adopted by CBs world over, i guess we may have to give RBI some freedom to do what it deems best to protect external value of its currency…
    If RBI continues to do the OMO (should target illiquids and longer tenor papers), INR liquidity can come back to market (to the extent the dollar swaps suck INR).
    Has any bank raised deposit rates in the last 8 weeks? here lies the anamoly…

  • Kaka says:

    Strangely, I haven’t been able to find really short term (< 6 month maturity) gilt funds by HDFC/ICICI/Templeton. I found one DSPBR Treasury Bill. And there are maybe 2 others from fund houses that I don't usually buy from. That's it. The lowest maturities for short term gilt funds at ICICI/HDFC/Templeton seem to be 3-4 years. Very strange.

  • Gold Bug says:

    This small uptick will be used by importers and FIIs to buy Dollars.

  • DD says:

    You’ve anticipated me – I am writing something similar for Monday. Wish you wouldn’t keep doing this 🙂
    Bloody good analysis – keep it up mate!