Indian banks pitch FX sell/buy swaps to drain surplus liquidity, sources say

Mumbai: Indian lenders proposed using foreign exchange sell/buy ​swaps to gradually withdraw ​excess rupee liquidity from the banking system at a ​meeting with the central bank on Thursday, three sources familiar with the discussion told Reuters.

Banking system liquidity surged to a record 9.7 trillion rupees ($102.66 billion) after ‌India drew $127 ⁠billion ⁠in foreign-currency deposits from non-residents under a special scheme, with the funds swapped directly with the Reserve Bank of India.

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The RBI has several tools to tighten liquidity, including forex swaps, bond sales and an increase in cash reserve ratio.

Bank executives who met the RBI favoured forex swaps, said ​the sources, who requested anonymity as they are ⁠not authorised ‌to speak with the media.

The central bank did ​not respond ​to a Reuters request for comments.

"A unanimous suggestion ⁠by the members was to conduct more dollar/rupee sell/buy ​swaps, as that will remove rupee liquidity without ​having any major impact on other asset classes," one of the sources said.

In a sell/buy swap, the central bank sells dollars to banks and receives rupees in the first leg of the transaction, before reversing the deal in the second leg.

Traders said the ‌RBI could conduct sell/buy swaps for up to a one-year tenor to match the dates of maturing short ​dollars in its ​forward book, which ⁠will effectively bring forward those maturities.

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According to the latest estimates, the RBI has outstanding forward dollar positions of about $45 billion maturing within one ​year. Conducting sell/buy swaps would allow the central bank to absorb a similar amount of surplus.

While suggesting this route, lenders urged the central bank to refrain from tweaking banks' cash reserve ratio, as that would impact bank margins, the sources said.