Context

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.

About

• A swap line is a temporary reciprocal currency arrangement between central banks.
• Under the arrangement, central banks agree to keep a supply of their country's currency available to trade to another central bank at the going exchange rate.
• Banks use it for overnight and short-term lending only. Most swap lines are bilateral, which means they are only between two countries' banks. 
• 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.

Challenges in Indian economy:

• The global shutdown of businesses around the world has wreaked havoc on financial markets as companies rush to secure cash to remain afloat while their sales dry up.
• Foreign institutional investors (FIIs) have been large sellers in the Indian equity and debt markets in March and April so far, as concerns over the economic effects of the COVID-19pandemic has hit investor sentiment.
• 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.

Significance of Currency Swap Line:

• Additional support: 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.
• Ensure liquidity: 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.
  • The liquidity is necessary to keep financial markets functioning smoothly during crises.

A significant monetary policy tool: It is a significant monetary policy tool. It reassures banks and investors that it is safe to trade in that currency and it also confirms that the central banks would not let the supply of that currency dry up.