Focus: GS-III Indian Economy
Why in news?
The Reserve Bank of India (RBI) has opened a six-month dollar sell-buy swap window to pump liquidity in the foreign exchange market — the first move following financial markets in India and across the globe experiencing turbulence over the spread of COVID-19, which could lead to a slowdown in growth.
What did the RBI say?
- RBI said the financial markets worldwide are facing intense selling pressures on extreme risk aversion due to the spread of COVID-19 infections, compounded by the slump in international crude prices and a decline in bond yields in advanced economies.
- It stands ready to take all necessary measures to ensure that the effects of the COVID-19 pandemic on the Indian economy are mitigated, and financial markets and institutions in India continue to function normally.
What is a Currency Swap?
- A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency.
- At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
- Unlike an interest rate swap, the principal is not a notional amount, but it is exchanged along with interest obligations.
- In a currency swap, the parties exchange interest and principal payments on debt denominated in different currencies.
- Currency swaps can take place between countries.
- The purpose of a currency swap is to hedge exposure to exchange rate risk or reduce the cost of borrowing a foreign currency.
How is this going to help?
It will help RBI in its efforts to fight market volatility.
The currency swap will provide liquidity to the foreign exchange market.