The Reserve Bank of India will conduct a massive $10 billion three-year dollar/rupee swap auction on 28 February to inject durable rupee liquidity into the banking system.

The first leg of the transaction would be settled on 4 March and could infuse around Rs 87,000 crore ($10 billion) into the banking system. 

Earlier this year, the RBI announced a six-month swap through which it infused $5.1 billion into the system. However, cash conditions have remained tight despite the swap and several open-market bond purchases. 

The RBI will need to inject at least another Rs 1 lakh crore into the banking system by March-end, market participants told Reuters.

Investors said three-year liquidity infusion is more assuring compared to a six-month, and far better than up to two-month repo infusions.

"The three-year maturity of the swap indicates that the RBI is looking at injecting more durable liquidity in the system possibly to ensure proper transmission of future rate cuts, the probability of which also has increased now," Reuters quoted Aditi Gupta, an economist with Bank of Baroda, as saying. 

The RBI also cut the repo rate for the first time in nearly five years earlier in February, but without sufficient cash in the banking system, rate cuts will not be effectively implemented by lenders, analysts said.

"This also suggests a possible shift in RBI's forex strategy, indicating a greater tolerance for a weaker currency as long as the depreciation is gradual and measured," Gupta said.

The RBI has infused more than Rs 3.6 lakh crore rupees of durable liquidity into the banking system in last five weeks through a combination of open market as well as secondary debt purchases, longer-duration repos and an FX swap.

The three-year swap would also be positive for shorter-duration government bonds and could lead to mild steepening in the yield curve, Reuters quoted a senior treasury official as saying.

"There may not be any immediate need for OMO purchase, but going into March, we could see some debt buying," the official said.

India's banking system liquidity deficit was around Rs 1.7 lakh crore as of 20 February and is set to widen further moving into the last month of the financial year when liquidity stress is maximum.