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5:40-42 - "If a man wants to sue you for your coat, let him have it and your overcoat as well. If anybody forces you to go a mile with him, do more - go two miles with him. Give to the man who asks anything from you, and don't turn away from the man who wants to borrow."

9 Nov 2018

MONEY MARKET--What does the currency swap agreement between India and Japan mean? How does it benefit the countries involved?

The Currency Swap Agreements between two countries are signed by the Central Banks — in this case, the Reserve Bank of India & Bank of Japan. In a Currency Swap, the RBI will get a certain amount of Yen (or USD) & the Bank of Japan will get an equivalent amount of Indian Rupees. This exchange is done according to the exchange rates prevailing at the time of the currency swap. On a later date, the exact opposite transaction takes place— RBI gives back that certain amount of Yen & it receives an equivalent amount of Indian Rupees from the Bank of Japan. All this while, the two central banks keep paying interests on the money exchanged. To me, this looks like two central banks simultaneously borrowing an equal sum of money from each other, albeit in two different currencies.

But how does the Agreement help us?

1.       As the US Dollar isn’t involved, this can boost our trade. The US dollar has been appreciating since April. In a working paper[1] published last year, Gita Gopinath had shown how the appreciation of US Dollar brings down the world trade. As the dollar appreciates, so do the prices because a large amount of trade is done using dollars. As the prices rise, the trade diminishes.
2.      The exchange rate at which the Yen will be paid back is decided in advance when the currencies are swapped. India Rupee has been depreciating for a long time now. Take the case of our informal Currency Swap arrangement with Iran. There was a dispute between the two countries regarding the exchange rate to be used while paying off for the import bills[2] . Iran wanted Rs. 5000 Crore as a compensation for the depreciation of Indian Rupee. In the India-Japan Case, such a problem would not arise, as the terms of the swap are already included in the agreement[3] .
3.      The Japanese Yen has much greater weight in the International trade than what Rupee has. So, when RBI has Yen reserves, it can use it to pay for the imports from Japan. Similarly, the Rupee lying in the Bank of Japan has to be spent somewhere. The Swap can make Rupee easily available to commercials banks in Japan. This can boost Indian exports to Japan. The same Indian Rupee can encourage more Japanese FDI in India.
4.      Such a large currency swap agreement, especially with a country like India whose currency is rapidly depreciating shows a sense of trust by Japan in Indian currency. This will help our currency with the perceptions & instil some trust in Indian Rupee. This improves market sentiment & speculative pressure on the Rupee.
India has foreign exchange reserves worth $393 Billion. It was about $426 Billion in April[4] . If god forbid, we have a liquidity crisis i.e. we do not have enough foreign currency to pay for our immediate imports, this $75 billion acts as the second line of defence. As India can also borrow dollars from Japan under this CSA, you can also look at this as an addition to our reserves


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