The RBI has already conducted two dollar swap auctions of $5 billion each and both the issues had got oversubscribed. Dollar swap auction is a means by the RBI to bring liquidity into the money markets and also prevent the rupee from becoming too strong. Let us view these in greater detail.

How does the dollar swap auction work?

In a dollar swap auction, the RBI collects the surplus dollar with the commercial banks and promises to repay it back after a period (in this case 3 years). The good thing is that the price at which the RBI will sell back the dollars to the banks is also decided in advance. In the second round of dollar swap auctions, the RBI had agreed to sellback dollars at a premium of Rs.8.70. Effectively, this becomes like a dollar deposit for the commercial banks with the RBI and their exchange risk is taken care of for the next 3 years. At the same time, the RBI buys dollars from banks in exchange for rupees and to that extent the rupee liquidity in the market goes up. Till now the RBI has collected $10 billion via dollar swap auctions and could do more.

How the dollar swap auctions impact the rupee / dollar rate?

When the RBI does dollar swap auctions, it buys dollars for banks and that creates demand for dollars. This helps in strengthening the dollar. But why does the RBI want to strengthen the dollar. That is aimed to protect the exporters who lose out if the dollar weakens. The RBI will use dollar swap auctions to give an indication of the range it is comfortable for the rupee to trade in. This makes the rupee more stable and also more predictable. The premium at which the RBI agrees to sell back the dollars can be used to give indications to either weaken or strengthen the rupee.