Some major Indian banks have asked the central bank to infuse liquidity through foreign-exchange swaps as short-term currency financing costs have risen to a four-year high.

Certain lenders have recently requested that the Reserve Bank of India consider employing FX swaps, in which the parties agree to exchange currencies in the spot market then reverse the transaction at a later date. Such actions could successfully increase rupee liquidity in the financial markets.

The demands occurred after an indicator for front-end currency borrowing prices spiked on Monday. The financial pressure was caused by a mix of seasonal reasons and an increase in foreign investors' demand for the rupee as they sought out local initial public offerings. 

Higher lending costs present a difficulty for the RBI in supporting an economy that is experiencing a slowdown in industrial operations. While it is uncertain whether the RBI will accede to the requests, the consequences of such an operation might put further pressure on the rupee, which has already been reaching new record lows since December.

On Monday, the rupee's tomorrow-next forward points rose to a level not seen since early 2021. Meanwhile, one-year implied forward yields on the rupee remained above two-year highs, underscoring the high costs of hedging against currency volatility.

An ongoing cash shortage, along with lenders' efforts to assist customer access to a recent flurry of local share sales, is driving the increase, according to the sources. Banks have also been hesitant to exchange rupees for dollars due to insufficient liquidity, worsening the funding pressure, they claimed. Analysts expect that the current tightening will persist. 

The swaps would involve the RBI buying dollars from banks against the rupee while agreeing to sell the greenback at a later date. When the central bank buys dollars, it injects an equal amount of rupee liquidity. 

Such operations are expected to reduce elevated finance costs. And by buying dollars on the first leg of the swap, the central bank would boost its foreign-exchange reserves, which have fallen to a seven-month low due to measures to protect the rupee from extreme volatility. 

The RBI last executed such a long-term exchange in April 2019 for three years and $5 billion.