The Reserve Bank of India (RBI) has recently been in the headlines for sealing a deal with the Maldives Monetary Authority (MMA). This agreement involves extending a currency swap facility worth up to $200 million under the SAARC Currency Swap Framework.
Understanding Currency Swap Arrangements
A ‘swap’ simply refers to an exchange. In financial terms, a currency swap between two nations is an agreement or contract wherein currencies are exchanged based on predetermined terms and conditions. The main aim of this arrangement is to offer swap support as an alternative source of funding, primarily for short-term foreign exchange liquidity needs. For instance, RBI had signed another currency swap agreement in 2020 to provide a $400 million extension to Sri Lanka. Central banks and governments frequently resort to currency swaps with their overseas counterparts to fulfil short-term foreign exchange liquidity needs or ensure sufficient foreign currency to avert a Balance of Payments (BOP) crisis. Since the transaction terms are preset, these swap operations do not pose exchange rate or market risks.
RBI’s Swap Facilities Framework for SAARC
The SAARC currency swap facility came into effect on November 15, 2012. Under this framework, the RBI can provide a swap arrangement within the overall corpus of $2 billion. These swap drawals can be carried out in US dollars, euros, or Indian rupees, with certain concessions provided for Indian rupee drawals. However, the facility is exclusively available to SAARC member countries, provided they sign the bilateral swap agreements.
About South Asian Association for Regional Cooperation (SAARC)
The South Asian Association for Regional Cooperation or SAARC was established on December 8, 1985, following the signing of the SAARC Charter in Dhaka, Bangladesh. The association includes Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. The SAARC secretariat is based in Kathmandu, Nepal. The main objective of SAARC is to promote the well-being of the people of South Asia, enhance their living standards, and expedite economic growth, among other agendas.
Correlation Between Currency Swaps and Currency Crisis Risks
Speaking about currency swaps in the context of India, certain factors play a significant role in mitigating the risks associated with a currency crisis. These include the IT sector’s foreign currency earnings and remittances from abroad by Indians. However, increasing government expenditure doesn’t necessarily contribute to reducing currency crisis risk. This insight is based on a previous year question (2019) from the UPSC Civil Services Examination.
