What are currency swap arrangements?
- In the swap arrangement, generally a country provides dollars to a foreign central bank, which, at the same time, provides the equivalent funds in its currency to the former, 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 two years later, using the same exchange rate as in the first transaction.
Why in News?
- Bangladesh has cleared a $200 million currency swap facility for Sri Lanka, to help boost its economy.
- With Sri Lanka’s main foreign exchange-earning sectors – tourism, export of garments and tea – badly hit due to the pandemic, the country has been struggling to maintain its reserves in the face of a daunting debt repayment schedule. In April 2021, Sri Lanka’s foreign reserves stood at $ 4.5 billion, about the same amount that the country is due to settle this year in external loan repayments.
- So far this year, Colombo has obtained financial assistance from China, through a $ 1.5 billion currency swap arrangement, and a $500 million loan, in addition to the $500 million extended last year. Sri Lanka also inked a $500 million loan-agreement with the EXIM Bank of Korea a fortnight ago.
- India, which extended a $400 million currency swap facility from the Reserve Bank of India – it was settled in February 2021 after an extension – is yet to respond to Sri Lanka’s year-old request for an additional $1.1 billion currency swap facility.
- The RBI offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion.
- This facility originally came into operation in 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 facility, RBI offers swaps of varying sizes in US Dollars, Euro or Indian Rupee to each SAARC member country depending on their two months import requirement.
- India also has a $75 billion bilateral currency swap line with Japan, which has the second highest dollar reserves after China.
Advantages of such arrangements
- These swap operations usually carry no exchange rate risk, as transaction terms are set in advance. The absence of an exchange rate risk is one of the major benefits of such a facility.
- This facility provides the country, which is getting the dollars, 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.