RBI, Maldives Monetary Authority sign swap pact

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. 

• 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.

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.