Recently, the Reserve Bank of India (RBI) with the concurrence of the Government of India has decided to put in place a revised Framework on Currency Swap Arrangement for SAARC countries for the period 2024 to 2027.
- The Currency Swap Facility will be available to all SAARC member countries, subject to their signing the bilateral swap agreements.
About the Currency Swap Arrangement for SAARC Countries
A currency swap between two countries is an agreement or contract to exchange currencies with pre-determined terms and conditions.
- Launched: In November 2012
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How Currency Swap Arrangement works in SAARC Countries?
- Suppose India signs a currency swap agreement worth $5 million with say, Nepal. India will then provide a loan to Nepal in a foreign currency which may be US Dollar.
- In return, Nepal will have to return the money in Indian Rupees at a fixed interest rate.
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- Objective: To provide a backstop line of funding for short-term foreign exchange liquidity requirements or balance of payment crises of member countries.
- Availability: The currency swap window will be available to all SAARC member countries, provided they sign bilateral agreements.
- Multiple Windows: Under the Framework for 2024-27, a separate INR Swap Window has been introduced with various concessions for swap support in Indian Rupee.
- The RBI will continue to offer swap arrangements in US dollar and euro under a separate window with an overall corpus of $2 billion.
About Currency Swap Arrangement
- Refers: Two parties exchange equivalent amounts of two different currencies and trade back at a later specified date.
- Currency swaps are often offsetting loans, and the two sides often pay each other interest on amounts exchanged.
- Currency swaps are over-the-counter (OTC) financial instruments. This means they are not traded on a centralized exchange.
- So far, the Commerce Ministry, Government of India, has finalized arrangements with some 23 countries with whom Indians can trade in local currencies such as Angola, Algeria, Nigeria, Iran, Iraq, Oman, Saudi Arabia, Yemen, Japan, Russia, etc.
- Conducted by: Financial institutions conduct most of the Foreign Currency (FX) Swap, often on behalf of a nonfinancial corporation.
- Significance: Swaps can be used to hedge against exchange rate risk, speculate on currency moves, and borrow foreign exchange at lower interest rates.
Uses of Currency Swaps
Institutions use currency swaps for a number of reasons.
- Allow companies to hedge their foreign exchange exposures.
- Help to lower financing costs, as it may be cheaper to borrow in a foreign currency.
- To gain access to a foreign currency.
- To take advantage of interest rate differentials between two countries.
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Limitations of Currency Swaps
Like any financial instrument, currency swaps possess several limitations and risks.
- Counterparty Risk: It means there is a risk that one of the parties may default on their obligations.
- Complexity: Some financial institutions may find it difficult to use them effectively.
- Significant Associated Costs: There may be significant costs associated with entering and managing the swap agreement, depending on the structure. These costs may be attributed to swap fees and hedging costs.
- Limited Liquidity: It makes it difficult to enter or exit a swap agreement at a favorable rate.
South Asian Association for Regional Cooperation (SAARC)
SAARC is a regional intergovernmental organization of South Asian countries.
- Establishment: In December 1985
- Member Countries: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka and Afghanistan
- Nine Observer States: China, the US, Myanmar, Iran, Japan, South Korea, Australia, Mauritius and the European Union.
- Headquarters and Secretariat: Kathmandu, Nepal
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June 28, 2024