Indian banks are becoming more cautious in the foreign-exchange market, retreating from a trade that had allowed them to profit from surplus rupee liquidity by buying dollars and parking the proceeds in US Treasury bills. The shift reflects rising sensitivity to the Reserve Bank of India's stance on liquidity management and cross-border flows, even as the underlying economics of the trade remain attractive.
Swap Trade Reassessed
The strategy at the centre of the pullback involves a buy-sell swap. Banks first purchase dollars in the spot market, then agree to sell dollars forward, effectively converting rupees into dollar funding for a fixed period. The dollars generated through these transactions were then deployed into US government securities, particularly Treasury bills, which have offered higher returns in recent months as US yields climbed.
The trade gained traction after banks found themselves flush with rupee liquidity, helped in part by inflows from non-resident Indian deposits. With domestic money abundant and short-term rupee returns comparatively subdued, the swap-and-invest model offered a relatively low-risk way to improve treasury income. But the same trade also increased banks' exposure to regulatory interpretation, especially if the central bank views the activity as contributing to volatility in the currency market or complicating liquidity transmission.
RBI Watchfulness Grows
Market participants say the caution is less about the profitability of the trade than about the possibility of closer RBI oversight. The central bank has historically been attentive to sharp movements in liquidity and foreign-exchange positioning, particularly when banks collectively move in the same direction. In this case, the concern is that a widespread shift into dollar assets could tighten domestic rupee conditions at the margin or create distortions in forward premiums.
The RBI has not publicly signalled any fresh restriction on such transactions, but banks are typically quick to adjust when they sense the regulator may be uncomfortable with a growing pattern of activity. That is especially true in a market where policy signals can be subtle and where institutions prefer to avoid drawing attention to trades that, while legal and common, may be viewed as opportunistic in a sensitive macro environment.
The backdrop matters. India's banking system has been operating with periods of surplus liquidity, even as the RBI has worked to keep money-market conditions aligned with its policy objectives. At the same time, the rupee has remained vulnerable to global dollar strength, oil prices and shifts in capital flows. In that setting, banks are weighing whether the incremental yield from US Treasury bills is worth the risk of being caught on the wrong side of a policy response.
Yield Gap Still Matters
The appeal of the trade has been reinforced by the rise in US government bond yields over the past three months. For banks with access to cheap rupee funding, the spread between domestic funding costs and dollar asset returns can be compelling, particularly when the currency hedge is embedded in the swap structure. That has made the transaction a useful treasury tool at a time when traditional lending margins remain under pressure.
Still, the economics are not static. If the RBI were to drain liquidity more aggressively, or if forward dollar pricing were to move unfavourably, the trade could quickly lose its edge. Banks are therefore trimming exposure or slowing fresh deals rather than exiting entirely, suggesting a tactical retreat rather than a structural abandonment of the strategy.
For now, the message from the market is clear: the opportunity remains, but so does the regulatory risk. As banks reassess the balance between yield and scrutiny, the pace of forex-linked treasury activity is likely to cool, at least until there is greater clarity on how far the RBI is prepared to tolerate the use of surplus rupees for offshore bond investments.