Currency Swap Agreement
The US Federal Reserve gave the Reserve Bank of India (RBI), as well as other central banks, a currency swap facility to help them fund their dollar requirements. The facility was so far extended to select central banks that did not include the RBI or the People’s Bank of China.
• On March 19, 2020, the Fed opened temporary swap arrangements with the central banks of Australia, Brazil, Denmark, South Korea, Mexico, Norway, New Zealand, Singapore, and Sweden, to be in place for at least six months for a combined $450 billion.
• The Fed already has permanent swap arrangements with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.
• Other large economies including India, China, Russia, Saudi Arabia and South Africa — all part of the G-20 grouping — currently do not have a currency swap line with the US.
• In roughly a month, India’s foreign exchange reserves have fallen by nearly $13 billion — from an all-time high of $487.23 billion on March 6 to $474.66 billion as on April 3, as per the latest data reported by the RBI.
• RBI had expressed the desire for a currency swap agreement with the Fed due to pressure on the rupee.
While India is largely expected to tide over any challenge posed by continued outflows of funds from the markets, a swap line with the US Federal Reserve provides additional comfort to the forex markets. Foreign institutional investors (FIIs) have been large sellers in the Indian equity and debt markets in March and April so far, as concerns over the economic effects of the COVID-19 pandemic have hit investor sentiment.
Even as the stock markets have seen a pullback from earlier low levels, there is apprehension that the economic impact of COVID-19 will last for a significant length of time, and there is unlikely to be any V-shaped recovery in the economy or in the financial markets.
This means that the government and the RBI cannot lower their guard on the management of the economy and the external account.
How does a Swap Facility work?
In a swap arrangement, the US Fed provides dollars to a foreign central bank, which at the same time, provides the equivalent funds in its currency to the Fed, based on the market exchange rate at the time of the transaction. The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even three months later, using the same exchange rate as in the first transaction.
These swap operations carry no exchange rate or other market risks, as transaction terms are set in advance. The absence of an exchange rate risk is the major benefit of such a facility.
Are India’s foreign exchange reserves enough?
Despite the slump in global crude oil prices and reduction in imports due to the pandemic outbreak, a sharp outflow of funds resulting from foreign portfolio investors (FPIs) looking for safer havens amidst the current global uncertainty, has pulled down India’s foreign exchange reserves.
FPIs invested a net of Rs 58,337 crore, or nearly $8 billion, between September 2019 and February 2020.
According to RBI data, 63.7% of India’s foreign currency assets — or $ 256.17 billion — are held in overseas securities, mainly in the US treasury. Some forex market participants believe that the country’s reserves at this stage — which are roughly equivalent to 12 months of import requirements — are sufficient to tide over any difficulty.
Does India have a Swap Line with any other country?
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India already has a $75 billion bilateral currency swap line with Japan, which has the second highest dollar reserves after China. This facility provides India with the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.
The Reserve Bank of India also offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion. This facility originally came into operation on November 15, 2012 to provide a backstop line of funding for short-term foreign exchange liquidity requirements or balance of payment crises until longer term arrangements were made. Under the framework for 2019-22, RBI will continue to offer a swap arrangement within the overall corpus of $2 billion.
The move will help stabilize markets, reduce volatility and ease pressure on currencies like the rupee.