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 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.
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.