By Jaikishan Parmar On March 26, the RBI conducted its first tranche of dollar swap auctions. Against the targeted amount of $5 billion, the RBI received bids to the tune of nearly $16.3 billion. This has led the RBI to announce the second round of dollar swap auction worth $5 billion on April 23. So, what exactly is a dollar swap? The dollar swap will offer a mechanism to convert bank dollar balances into rupees. Dollar swap is based on two essential premises. Firstly, the dollar infuses rupee liquidity into the system and thus plays the same role as the open market operations. At the same time, it also enhances the dollar reserves of the RBI and indirectly supports exporters by capping the appreciation of the rupee. Before getting into liquidity aspects, let us focus on the modus operandi of dollar swaps. Also read: Share market LIVE: Sensex, Nifty at fresh record high; Bharti Airtel, Yes Bank shares top gainers How exactly does the dollar swap work? Here are four important points you must comprehend about a Dollar Swap. Swap auctions will be open to banks and have tenure of 3 years. Swap will be closed-ended with sale and repurchase price predetermined like a repo. Typically, banks will bid on the forward rates, which will be lower than market rate. Banks monetize their dollar holdings and the RBI builds forex reserves. Why can\u2019t the RBI do the same through OMO? Back in December 2018, the net liquidity shortfall was nearly Rs 100,000 crore. Despite the RBI infusing Rs 40,000 crore monthly through OMOs, the shortfall still exists. RBI also has a balance sheet problem. Last year, RBI absorbed 75 per cent of government\u2019s bond issuances in its \u00a0balance sheet. Dollar Swap offers an alternate method to infuse liquidity into the market. Can the RBI hit multiple birds with one stone? Clearly, there are 3 objectives that the Dollar swap will achieve for the government; and each are equally mission-critical. Domestic liquidity gets enhanced by Rs 35,000 crore each month at $5 billion. RBI shores up its forex chest by $5 billion each month with room for more. Exporters benefit as the rupee appreciation is capped by dollar demand from RBI. Will the dollar swap impact yield curve and hedging costs? In fact, the dollar swap will impact the yield curve and hedging costs. Here is how! The dollar swap leads to additional infusion of liquidity which will bring down yields at the short end of the curve. This creates a smoother yield curve and sharper credit pricing. Secondly, for hedgers, this back-to-back transaction becomes the benchmark for costs and may actually bring down hedging costs. India\u2019s Forex cover has fallen to just about 9 months of imports. That is way below what Brazil, Russia and China maintain. The dollar swap auctions can fill the gap. The author is Senior Equity Research Analyst - BFSI, Angel Broking. The views expressed are the author\u2019s own.