RBI Conducts FX Swaps Amid Surging Hedging Costs

India's central bank conducted foreign-exchange swaps on Tuesday, according to people familiar with the matter, a move that cooled a sharp rise in hedging costs.

The Reserve Bank of India conducted buy-sell swaps in maturities of up to one-year, with some of these in the one-month segment, the people said, asking not to be named while discussing private matters. In such swaps, the central bank buys dollars from lenders and pledges to sell them at a later date.

Following the step, one-month dollar-rupee onshore forward yields fell to a low of 5.80%, down sharply from a four-and-a-half-year high of 6.99% hit earlier in the day. Forward yields of other maturities also eased.  

The move comes after some lenders had individually requested the central bank to carry out short-term foreign-exchange swaps, such as one-to-three-month deals, Bloomberg News reported earlier Tuesday. Such swaps would allow banks to deploy excess dollars they hold after recent RBI interventions to support the rupee, they said.

Hedging costs had surged as dollar-rupee forward premiums jumped sharply. The spike has eroded foreign investor returns on Indian assets, Morgan Stanley analysts including Nimish M Prabhune wrote in a note. The spurt reflects banks swapping surplus dollars left by RBI intervention into rupees, while agreeing to buy the greenback later, the people said. 

The developments show how the RBI’s efforts to shore up the rupee — Asia’s worst performer this year — are creating fresh challenges for banks. It also highlights the central bank’s challenge in supporting the currency while minimizing the fallout of those measures on the economy. 

A spokesperson for the RBI did not immediately respond to an email seeking comment on the central bank’s forex swaps.

The spurt in hedging costs has unsettled global investors. They’ve sold $1.4 billion of index-eligible local bonds so far in December, on track for the highest outflow since the nation’s debt was added to global indexes in June 2024. Outflows from stocks are nearing $950 million for the month. 

While the RBI recently carried out a $5 billion swap auction, it was for three years, rather than the short tenor operations that banks were seeking.

Under central bank rules, banks must limit their dollar exposure. Foreign lenders, in particular, often swap surplus dollars into rupees to meet these requirements, especially toward the year-end.