Opinion | The ‘Das put’ and how risk capital works

The Reserve Bank of India’s (RBI’s) unconventional liquidity management tool in the form of a dollar-rupee swap might quell some temporary storms and stabilize transitory unevenness, but leaves multiple questions and issues unanswered. While RBI governor Shaktikanta Das said that the response has been positive so far, the exact nature of the impact will only be known by April 2022, when the reverse leg of the swap unfolds.

A $5-billion, three-year dollar-rupee swap by the central bank with commercial banks to primarily increase “durable” liquidity in the system is bound to have multiple ripple effects. The first obvious outcome will be a definite increase in liquidity when RBI buys dollars and releases rupees in the market. Second, the surge of liquidity, combined with a downward pressure on premiums for near-term forward contracts, will influence interest rates in the economy. Third, RBI has often expressed its concern over rupee-dollar trades moving to the non-deliverable forward markets of Singapore, Dubai and London. This swap might draw some of that activity back to local markets. Fourth, the appreciation of the rupee since the forex swap announcement on 13 March—over 1% till 22 March—seems to indicate that India’s central bank now has a higher tolerance level for its rise against the dollar.

Despite these certain outcomes, the governor’s actions can be viewed through different lenses. In some ways, his adoption of this curious liquidity tool to increase systemic liquidity can also be seen as his way of ensuring that Indian markets do not search for new bottoms.

Till market closing on 22 March, the BSE Sensex had gained 1.7% since the swap was declared. Comparisons are being made with a market strategy adopted when Alan Greenspan was chairman of the US Federal Reserve, which came to be known as the “Greenspan put”; in simple words, players expected the Fed to intervene by easing its monetary policy every time markets hit a speed-breaker. This pretty much continued till the financial crisis erupted and forced a rethink of the Fed’s dominant tenets.

Scheduled this week, RBI’s swap will have one obvious outcome: higher dollar inflows as lower hedging costs encourage Indian companies to borrow more overseas and foreign portfolio investors find rising returns from rupee assets.

The political ramifications of RBI’s liquidity play also seem inescapable. The need to increase liquidity at such a time seems counter-intuitive. Historical data has proven that the currency available with the public surges before and during elections. As on 1 March, while broad money, or M3, showed a growth of 10.5% on a year-on-year basis, currency with the public jumped 18%.

Agreed, this is short-term and inherently volatile, given that large outflows are expected at the end of the fiscal year on 31 March for tax purposes. But then pumping in extra liquidity when the economy is slowing and elections are about to take centre stage for next three months is bound to have some impact on inflationary expectations, albeit with a lag.

The uninterrupted rupee appreciation is the other reason. Certain political dispensations view an appreciating rupee as a virile symbol, a beacon of inner strength. It would indeed be unfortunate if, during the election campaign, political parties use the strengthening rupee as a validation of their economic policies. If economic history has taught us one lesson, it is this: monetary policy and politics don’t mix well.