14/04/2020 - Indian Economy

KEY POINTS

·         India is working with the United States to secure a dollar swap line that would help in better management of its external account and provide extra cushion in the event of an abrupt outflow of funds.

·         India already has a $75 billion bilateral currency swap line with Japan, which has the second highest dollar reserves after China. The Reserve Bank of India also offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion.

What are the benefits of a swap line?

·         While India is largely expected to tide over any challenge posed by continued outflows of funds from the markets, a swap line with the US Federal Reserve provides additional comfort to the forex markets.

·         Even as the stock markets have seen a pullback from earlier low levels, there is apprehension that the economic impact of COVID-19 will last for a significant length of time, and there is unlikely to be any V-shaped recovery in the economy or in the financial markets.

·         This means that the government and the RBI cannot lower their guard on the management of the economy and the external account.

·         According to RBI data, 63.7% of India’s foreign currency assets — or $256.17 billion — are held in overseas securities, mainly in the US treasury. Some forex market participants believe that the country’s reserves at this stage — which are roughly equivalent to 12 months of import requirements — are sufficient to tide over any difficulty.

How does a swap facility work?

·         In a swap arrangement, the US Fed provides dollars to a foreign central bank, which, at the same time, provides the equivalent funds in its currency to the Fed, based on the market exchange rate at the time of the transaction.

·         These swap operations carry no exchange rate or other market risks, as transaction terms are set in advance. The absence of an exchange rate risk is the major benefit of such a facility.

Please review it 

As per the RBI's latest reports,India's foreign reserves fell by $13 billion,The fall in foreign exchange reserves is due to the sharp outflow of Foreign Portfolio Investments from Indian equity and debt market amidst pandemic crisis.

Necessity of American Dollar :

There is a huge demand for American Dollar as it is involved in major foreign transactions because of its value across the globe.India imports 82% of oil to meet its needs where the transaction takes place in terms of US Dollar.India is an import driven country,which obviously requires American Dollars in massive amount.Dollar swap line is one of the important mechanisms for India to meet its demand for the dollar.

Dollar Swap Line :

The US Fed provides dollars to a foreign central bank,in return the foreign central bank provides the equivalent funds in its currency to the Fed,based on the market exchange rate at the time of transaction.The parties agree to swap back these quantities of their two currencies at a specified date in the future,using the same exchange rate as in the first transaction.

Importance of Dollar Swap Line Arrangement :

India can acquire dollars through different methods like Foreign Portfolio Investments in Indian equity and debt market,issuing various bonds etc but these methods are highly risky because of their volatile nature.Dollar swap line arrangement carries no exchange rate or other market risks,as transaction terms are set in advance.This really helps India a lot as the value of rupee against dollar is highly volatile.Due to uncertain conditions like Covid 19 pandemic,this volatility becomes really high.

India already signed a $75 billion dollar swap agreement with Japan in 2019.This agreement provided India with flexibility to use these reserves in order to maintain short term liquidity,appropriate level of balance of payments.Thus Dollar Swap Line Arrangement gives an edge for a country to fill its reserves without risk mostly during uncertain times.