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EXPLAINED: HOW A DOLLAR SWAP LINE WITH US FED CAN HELP

Why in news?

  • India is working with the United States to secure a dollar swap line that would help in better management of its external account and provide extra cushion in the event of an abrupt outflow of funds, according to banking industry and government sources.
  • India already has a $75 billion bilateral currency swap line with Japan, which has the second highest dollar reserves after China.
  • The Reserve Bank of India also offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion.

What are the benefits of a swap line?

  • 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 has hit investor sentiment.

Are India’s foreign exchange reserves enough?

  • 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.
  • 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.
  • After a smooth run during which India’s foreign exchange reserves rose week-on-week for nearly six months, they started to decline in March. FPIs invested a net of Rs 58,337 crore, or nearly $8 billion, between September 2019 and February 2020.

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.

Does India have a swap line with any other country?

  • In 2019, India signed a $75 billion bilateral currency swap line agreement with Japan, which has the second largest 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.
  • Last November, to further financial stability and economic cooperation within the SAARC region, the RBI put in place a revised framework on currency swap arrangement for SAARC countries for 2019-22.
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September 2022
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