Currency Swap Line

In the wake of the coronavirus pandemic, 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.

As per the latest data reported by the RBI, India’s foreign exchange reserves have fallen by nearly $13 billion — from $487.23 billion on March 6 to $474.66 billion as on April 3, 2020.
According to RBI, 7% of India’s foreign currency assets — or $256.17 billion — are held in overseas securities, mainly in the US treasury.

Despite the slump in global crude oil prices and reduction in imports due to the pandemic outbreak, a sharp outflow of funds resulting from foreign portfolio investors (FPIs) looking for safer havens amidst the current global uncertainty, has pulled down India’s foreign exchange reserves.
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.

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.
The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even three months later, using the same exchange rate as in the first transaction.
Most swap lines are bilateral, which means they are only between two countries' banks.

The purpose of a swap line is to keep liquidity in the currency available for central banks to lend to their private banks to maintain their reserve requirements.
It reassures banks and investors that it's safe to trade in that currency.
It also confirms that the central banks won't let the supply of that currency dry up.
It's another monetary policy tool.

In 2019, India signed a $75 billion bilateral currency swap line agreement with Japan, which has the second largest dollar reserves after China.
This facility provides India with the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.
In November, 2019, the RBI put in place a revised framework on currency swap arrangement for SAARC countries for 2019-22 in order to provide financial stability and economic cooperation within the SAARC region.

This facility originally came into operation on November 15, 2012 to provide a backstop line of funding for short-term foreign exchange liquidity requirements or balance of payment crises until longer term arrangements were made.
Under the framework for 2019-22, RBI will continue to offer a swap arrangement within the overall corpus of $2 billion.
Other countries can withdraw funds in the US dollar, the euro, or the Indian rupee.

The Fed already has permanent swap arrangements with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.
On March 19, 2020, the U.S. Federal Reserve( Fed) opened temporary swap arrangements with the central banks of Australia, Brazil, Denmark, South Korea, Mexico, Norway, New Zealand, Singapore, and Sweden, to be in place for at least six months for a combined $450 billion.
Other large economies including India, China, Russia, Saudi Arabia and South Africa — all part of the G-20 grouping — currently do not have a currency swap line with the US.

While swap lines were initially used by central banks to fund certain market interventions, in recent years they have become an important tool for preserving financial stability and preventing market tension from affecting the real economy.

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.
Drawing on the swap line increases the dollar money supply. Because this meets an increase in demand for dollars by recipient country banks, it is in principle consistent with controlling inflation.