Understanding how currency-swaps work

As the Indian rupee tumbled against the US dollar since the month of August, government swung into action by inking a currency-swap deal and boosting market confidence. India signed a currency-swap deal with Japan which enhanced swap facility from $15 billion to $50 billion till December 2015. The Reserve Bank of India said, It is expected that this will contribute to the stability of financial markets.

Last year, the Bank of Japan and the Reserve Bank of India signed bilateral swap deal for $ 15 billion. It was aimed at addressing possible short-term liquidity mismatches and supplementing existing international financial arrangements.

1) What is a currency-swap deal?

Under this arrangement, two countries or parties exchange specific amounts of different currencies for a period of time. In the latest agreement between New Delhi and Tokyo, both the sides will accept the Indian rupee and the Japanese yen. According to Montek Singh Ahluwalia, the deal between India and Japan would add firepower to Indias reserves (By August 30, Indias total forex reserves were at $275.49 billion, lowest in the last 39 months) and second line of defence for the rupee.

Apart from Japan, India has currency swap deal of $100 million with its neighbouring country, Bhutan. Another neighbour China has also signed a currency swap deal with Britain and France in 2013. Russia and Brazil also swap currency with China. New Delhi and Beijing have also shown interest in entering into an agreement and India is aiming such agreements with other BRICS countries.

Basically, it has become an important derivative tool to hedge the exchange rate risks after the global financial crisis hit in 2008.

2) What are the various ways one can undertake a currency-swap deal?

There are four ways of basic currency swaps: fixed for fixed, fixed for floating, floating for fixed and floating for floating. Such deals are motivated by comparative advantage.

In a currency swap agreement, two parties exchange one currency for another on one value date and then reverse the transaction on another value date.

It can also be done to facilitate the exchange of principal and interest payments of a loan in one currency for an equivalent loan in another currency.

India also currency-swaps with Iran in an informal way while making payment for crude oil purchases. As there is western nation sanction on Iran, under this agreement, Iran takes payment of crude sold to India in Indian rupees.

3) Why do you need a currency-swap deal?

The main aim is to convert a liability in one currency into a liability in another currency. It also converts an investment (asset) in one currency to an investment in another currency.

4) How serious is the Indian government on currency-swap deals?

In August, government formed an eleven-member task force to work on currency-swap agreements. The task force has members from the commerce ministry, department of economic affairs and financial services, Reserve Bank of India (RBI), State Bank of India (SBI), Confederation of Indian Industry (CII), Federation of Indian Chambers of Commerce and Industry (FICCI) and exporters body Federation of Indian Export Organisation (FIEO).

5) What does the task force do?

Firstly, the task force will study different arrangements and its implications on Indias trade and financial system besides studying the pros and cons of such pacts on the countrys commerce. Secondly, it would also identify countries with which India can have currency-swap agreements and make recommendations.

The task force is likely to submit recommendations to the department of commerce by the end of September.

6) What are the RBIs new norms for dollar-rupee swap window?

The RBI has opened a new window foreign currency non-resident (banks) for swapping dollar funds. Under this facility, a bank can sell dollars to RBI and at the end of the swap period, the banks would have to buy the same amount of dollars.

Such swap windows will remain operational between September 10 and November 30. It will be mobilised for a minimum tenure of three years and above at a fixed rate of 3.5 percent per annum for the tenure of the deposit.