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RBI, Maldives Monetary Authority sign swap pact

  • Published
    10th Dec, 2022
Context

The Reserve Bank of India (RBI) has signed an agreement to extend up to a $200 million currency swap facility to Maldives Monetary Authority (MMA) under the SAARC Currency Swap Framework.

About

About the agreement:

  • Objective: This agreement will enable the MMA to make drawals in multiple tranches up to a maximum of $200 million from the RBI.
  • The facility is to provide swap support as a backstop line of funding for short-term foreign exchange liquidity requirements, it said. 

In 2020, the RBI signed a similar pact for extending up to $400-million currency swap facility to Sri Lanka.

  • Significance:
    • The swap drawals can be made in US dollars, euros or Indian rupees. 
    • The framework provides certain concessions for swap drawals in the Indian rupee.
    • Currency swaps are used to obtain foreign currency loans at a better interest rate than a company could obtain by borrowing directly in a foreign market or as a method of hedging transaction risk on foreign currency loans that it has already taken out.

The SAARC Currency Swap Framework:

  • The SAARC Currency Swap Framework came into operation on November 15, 2012.
  • It is a currency swap between two countries under an agreement or contract to exchange currencies with predetermined terms and conditions.
  • SAARC swap Arrangement entails currency swaps between the SAARC countries.
  • It is mostly done to meet short-term foreign exchange liquidity requirements or to ensure adequate foreign currency to avoid the Balance of Payments (BOP) crisis.
  • SAARC swap Arrangement framework includes:
    • RBI will offer a swap arrangement within the overall corpus of USD 2 billion.
    • Swap withdrawals can be made in US dollars, Euros or Indian rupees.
    • The facility will be available to all SAARC member countries, subject to their signing of bilateral swap agreements.

How does this swap mechanism work between the parties?

  • A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency.
  • At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
  • During the length of the swap, each party pays the interest on the swapped principal loan amount.
  • At the end of the swap, the principal amounts are swapped back at either the prevailing spot rate or at a pre-agreed rate such as the rate of the original exchange of principals.
  • Using the original rate would remove transaction risk on the swap.
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