Currency Swap Agreement – Understanding the basics

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By admin April 20, 2019 16:38

Currency Swap Agreement – Understanding the basics

During the India-Japan Summit held last year, both countries agreed to enter into a bilateral currency swap arrangement of $75 billion which is one of the largest Currency Swap Agreements in the world.

 

What is a Currency Swap Agreement?

  • The currency swap agreement is an agreement to exchange currency between two foreign parties.
  • In fact, all the agreement which consists of generally swapping principal and also interest payments on a loan made in one currency, for principal and interest payments of a loan of equal value in another currency.
  • In simple terms, it is an open-ended credit line from one country to another at a fixed exchange rate. The country which avails itself of this loan pays interest to the country which provides it, at a much lower benchmark interest rate.

 

Advantages of Currency Swap Agreement

  • The main purpose of engaging in a currency swap is usually to procure some loans in foreign currency at more favourable interest rates than if borrowing directly in a foreign market.
  • It can help to reduce exposure to anticipated fluctuations in exchange rates.

 

Advantages for India from the currency swap agreement with Japan

 

  • This agreement will allow the RBI to draw up to $75 billion worth of yen or dollars as a loan from the Japanese government whenever it needs this money. ¬†Moreover, the RBI can either sell these dollars (or yen) to importers to settle their bills or to borrowers to pay off their foreign loans.
  • The RBI can even hang on to the money to shore up its own foreign exchange reserves and defend in the rupee (see below)
  • Moreover, this facility will enable only the agreed amount of foreign capital being available to India for use as and when the need arises. So, there is no immediate cost and interest kicks in only when an amount is withdrawn by India.
  • It would bring greater stability to foreign exchange & capital markets in India thereby improving market sentiments.
  • India can acquire Yen or Dollars from Japan up to $75 billion in exchange for Rupees and will help meet short-term liquidity mismatches.

 

How it can serve as a second line of defence for the Rupee?

 

It would serve as a second line of defence for the Rupee after the foreign exchange reserves that the RBI has at its disposal.

 

In late 2018, the rupee had been falling against all the dollar mainly because of the widening current account deficit (the difference between imports and exports of goods and also services). This led to importers upping their demand for dollars far beyond what exporters bring into the country.

RBI had to use up some of the foreign exchange reserves to prop up the rupee. Though present forex reserves are still comfortable, having a $75-billion loan-on-demand from Japan gives the RBI an additional buffer to fall back on, should it need extra dollars in such situations.

 

A swap arrangement with the country Japan provides some considerable comfort to our country India because Japan is the second largest holder of dollar reserves in the whole world after the country China and has reserves to the tune of over $1,250 billion. Therefore, while Japan is quite unlikely to ask India for a dollar loan, India can make use of such a loan at rock-bottom interest rates.

 

Vantage Point for PT

Currency swap agreement between India and Japan was in news recently. Which of the following can be advantages of this agreement?

  1. It can help RBI to prop up the Rupee, should a need arises for such appreciation.
  2. It can be used to swap principal and interest payments on a loan made in one currency, for principal and interest payments of a loan of lesser value in another currency.

Choose the right answer from the codes given below.

a) 1 only

b) 2 only

c) Both 1 and 2

d) Neither 1 nor 2

Answer : a)

Explanation

 

Statement 1 is correct but statement 2 is not like the exchange of loans is of equal value in another currency and not lesser value.

Read Also: 15th Finance Commission of India

admin
By admin April 20, 2019 16:38