Recently,
the government announced that it has formed a task force to explore the
possibility of a currency swap agreement for trade purposes.
The task force consisting of representatives from the Ministry, Department of Economic Affairs, Reserve Bank of India (RBI), SBI, industry bodies FICCI, CII and Federation of Indian Exporters Organisation (FIEO) will look at the possibility of trading in local currency and advise on its advantages and disadvantages. It has also been clarified that the proposed agreement will be different from the current currency swap agreement of the central banks.
The task force consisting of representatives from the Ministry, Department of Economic Affairs, Reserve Bank of India (RBI), SBI, industry bodies FICCI, CII and Federation of Indian Exporters Organisation (FIEO) will look at the possibility of trading in local currency and advise on its advantages and disadvantages. It has also been clarified that the proposed agreement will be different from the current currency swap agreement of the central banks.
What is currency swap?
- Currency
swaps were invented in 1970s to bypass capital controls prevalent in
various parts of the world.
- Here’s
what they basically are.
1.
Let’s say, company 'A'
needed to borrow in US dollars but was not allowed to do so in its home
country, say, India.
2.
At the same time, a
US company wants to increase its investment in India.
3.
Now the Indian
company will borrow in rupees and lend to the US company in India, while the US
company will borrow in dollars and lend it to the Indian company in the US.
There is a lot of innovation that has
happened since.
For example,
companies now hedge their future cash flow in foreign currency by entering into currency swap
contracts.
Debt and interest payments are also hedged through currency swaps.
The present plan
- Currently,
the government of India is exploring options of trading in the Indian
rupee with large trading partners.
- If Indian importers are able to settle bills in rupees, it
will lessen demand for dollars and will reduce the pressure on the rupee
in the currency market.
- Trading
partners that accept rupee will use it for importing goods from
India.
- However,
how far will such measures help stabilize the rupee is debatable. For example, what will be the incentive for
our trading partners for entering into such an agreement?
- Also,
since India runs a large deficit on the current account, the impact on the total demand for foreign
currency could be minimal.
Swap agreements of central
banks
- The
government has clarified that what they intend to do will be different
from existing agreements of central banks.
- Central
banks swap their currency for a specified period.
- For
example, since most of the global trade happens in US dollars, the Federal
Reserve provides a dollar liquidity swap line to
other central banks.
- Under
this facility, the Federal Reserve enters into an agreement with
a foreign central bank to buy its currency at the existing exchange
rate.
- However, the foreign central bank will have to buy back its own
currency from the Federal Reserve at a specified date, but at the exchange rate used in the first
transaction.
- This
helps central banks to address temporary dollar liquidity crunch in their
respective countries.
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- Currency swap has emerged as an important derivative tool after the global financial crisis of 2008 to hedge the exchange rate risks.
- India has signed currency swap agreements with Japan ($15 billion) and Bhutan ($100 million).
- China has shown active interest in entering into such an agreement with India, but it is yet to be signed.
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The inter-departmental group of the Commerce Ministry will also
have representation from Export Credit Guarantee Corporation of India. It would
explore the possibility of using local currency for trade with major trading
partners and advice on pros and cons of the same, it added.