What is a Currency Swap Facility?
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The term swap means exchange. Under this agreement, two contracting countries loan each other a specified amount in local currencies or any major currency.
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The parties agree to swap back this amount at a specified date. It uses the same exchange rate as agreed initially.
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This facility often uses the local currencies of the countries under agreement. Thus, it eliminates the need for the currency of any other country like US Dollars.
Benefits of Currency Swap facility:
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The swap operations carry no exchange rate or other market risks. The transaction terms are set in advance.
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It reduces the need of maintaining foreign exchange reserves for bilateral trade. Thus, it promotes bilateral trade.
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Hence, it ensures financial stability (protecting the health of the banking system).
Examples of Currency Swap Arrangement:
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India-Japan Currency Swap:
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In 2018, India and Japan had signed a bilateral currency swap agreement.
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Under this, RBI will get a certain amount of yen or dollars and the Bank of Japan will get an equivalent amount in Indian rupees on a decided swap rate.
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After a specified period, both the countries will repay the amount at the same swap rate.
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SAARC Currency Swap Framework 2019-22:
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It came into operation in 2012. In 2019, the RBI revised the framework from 2019-2022. Under this, RBI will continue to offer swap arrangement within the overall corpus of USD 2 billion.
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The currency swap facility will be available to all SAARC member countries subject to their signing the bilateral swap agreements.
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Based on the terms and conditions of the framework, the RBI would enter into bilateral swap agreements with SAARC central banks who want to avail swap facility.
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The drawls can be made in US Dollars, Euro, or Indian Rupee. The framework also provides certain concessions for swap drawals in Indian Rupee.
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The Central Bank of Sri Lanka(CBSL) has settled a $400 million currency swap facility from the Reserve Bank (RBI) of India.
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Bangladesh and Sri Lanka signed a $200 million currency swap agreement.