Context: India is working with the United States to secure a dollar swap line that would help in providing an additional comfort in an event of any abrupt outflow of funds.
Need of dollar swap:
- India will liquidate its foreign currency assets like investment in US treasury etc. to stabilise the rupee which has been under pressure of late.
- Concerns on the economic effects of COVID-19 is hitting investor sentiment.
- Falling rupee value: India liquidated its forex assets to stabilise the rupee which recently fell below the 76 level against the dollar. India’s foreign currency assets had declined by around $7.50 billion in two weeks to $ 439.66 billion as on March 27.
- Risk-averse financial markets worldwide: 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.
- As per the NSDL (National Securities Depository Limited) data, foreign investors have pulled out foreign capital worth Rs 33,164 crore in local debt and equity since the start of March.
Dollar Swap arrangement:
- The US Federal Reserve provides dollars to a foreign central bank. At the same time, the foreign central bank provides the equivalent amount of 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 is the next day or as far ahead as three months, using the same exchange rate as in the first transaction.
Advantage of dollar swap:
- It will add to the RBI’s arsenal in managing external accounts and excessive volatility in currency markets.
- India has enough foreign exchange reserves now and the external sector is not facing any problem.Dollar swap will provide additional comfort in case of further outflows from the Indian markets.
- These swap operations carry no exchange rate or other market risks as transaction terms are set in advance.