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India-Japan sign currency swap agreement: Weak rupee against a rising dollar, depleating forex reserve led to $75 bn deal

FP Staff
Japan and India on Monday entered into a $75-billion currency swap agreement. The deal comes in at a time when the country is battling with the depreciating value of rupee as opposed to the dollar.

A $75-billion currency swap agreement between India and Japan has come at a time when the country is battling with the depreciating value of rupee as opposed to the dollar.

The agreement was signed in Japan on Monday during Prime Minister Narendra Modi's two-day visit to the nation on account of the 13th India-Japan Annual Summit. "India and Japan agreed to enter into a bilateral swap arrangement of $75 billion. This swap arrangement would be 50% higher than our last swap agreement," Finance Minister Arun Jaitley tweeted. Meanwhile, the finance ministry tweeted that: "This new swap agreement should aid in bringing greater stability to foreign exchange and capital markets in India... and will further strengthen and widen the diversity of economic cooperation" between the two nations."

Under the arrangement, India can seek dollars from Japan in exchange for the rupee. Whereas, Japan can also acquire dollars from India in exchange for yen. It will help meet short-term liquidity mismatches, The Economic Times reported.

However, this is not the first time there has been such an offer from Japan. Japan had offered a $50 billion (increased from $15 billion) currency swap in 2013 as well and even before that, one for $3 billion in 2008.

"Bilateral swap arrangement with Japan for $75 billion is one of the largest swap arrangement in the world. Accepting Japanese request, India agreed to do away with the requirement of mandatory hedging for infrastructure ECBs of 5 years or more minimum average maturity," economic affairs secretary Subhash Chandra Garg tweeted. On the other hand, Shaktikanta Das, a member of the 15th Finance Commission, tweeted, "India Japan currency swap agreement will have a positive impact on the financing of our Current Account Deficit(CAD). A strong signal to our financial and currency markets."

It is interesting to note that, Japan's currency swap agreement with India comes less than a week after it entered into a similar pact with China for $30 billion.

Yen loan for bullet train project

In addition, both sides also agreed to lend Yen loans to India for the construction of the Mumbai-Ahmedabad High-Speed Rail (II) and to allow trade in local currencies rather than using US dollars. The envoys of both the nations "exchanged notes concerning the provision of Yen loan related to seven projects including the project for the construction of the Mumbai-Ahmedabad High-Speed Rail (II) (total loan provision of up to 316.458 billion Yen, approximately Rs 20,674.201 crore )", the India-Japan joint statement said. "This swap arrangement particularly reflects the depth of mutual trust and understanding, personal relationship and warmth between the two leaders built over many years," the statement added.

However, the Reserve Bank of India (RBI) is yet to address the hedging requirement for investment in infrastructure, India Today reported.

Rise of dollar against rupee

Of late, the central government and banks around the world, especially those in emerging economies, have been taking policy measures to address dollar appreciation and improve the availability of foreign capital. The policy interest rate in the United States has seen a gradual increase in the recent months and this is one of the causes of the dollar strengthening against other global currencies.

And therefore, to address issues of outward flows of foreign capital €" which in turn drains the foreign exchange reserve €" India has taken various steps towards containing the current account deficit (CAD) and keeping the rupee volatility in check. These include relaxations in external borrowing policy, issuing off-shore rupee/masala bonds, reviewing restrictions on foreign portfolio investment in debt, hike in customs duty for curtailing imports of non-essential items and financing standing working capital of oil-marketing companies (OMCs) by long-term external borrowings, among others. The decision to enter into a currency-swap agreement with Japan is also a vital step in that direction.

According to a report in The Financial Express, the rupee has slid around 14 percent in the last one year and emerged as Asia's worst-performing major currency amid a spike in the global oil prices. This has prompted authorities to even get into a barter trade system with oil-exporting countries like Iran and Russia. This facility is expected to raise the country's forex reserve of $393.5 billion by $75 billion, the report said.

Currency swap 

The currency swap is an agreement between two countries to trade in their local currencies, where both pay for import and export at pre-determined rates of exchange without bringing in a third currency. That is, it typically involves the exchange of interest and sometimes of principal in one currency for the same in another currency. Interest payments are exchanged at fixed dates through the life of the contract and it is considered to be a foreign exchange transaction which is not required by the law to be shown on a company's balance sheet.

So, in India and Japan's case, the Reserve Bank of India and the Bank of Japan will enter into the agreement for a swap of funds in each other's currencies and the borrowing bank will pay an interest for the use of funds. Foreign investors and financial facilitators are expected to hail this move as they would put in more confidence in a country which is dealing with fewer risks in trade.

India has reportedly, extended such currency swap agreement to 23 countries so far, including major oil-exporting nations like Iraq, Iran, Qatar, Saudi Arabia, Yemen, Angola, Algeria, Nigeria, Oman, and Venezuela. Japan, Russia, Australia, South Korea, Singapore, Indonesia, Malaysia, Mexico, South Africa and Thailand are some of the other countries with which India has initiated agreements.

In November 2015, the RBI had also extended currency swap arrangement to the South Asian Association for Regional Cooperation (SAARC) nations till mid-November 2017. All 7 SAARC member countries including Bangladesh, Afghanistan, Maldives, Bhutan, Nepal, Pakistan and Sri Lanka were offered a swap arrangement up to an overall amount of $2 billion dollars both in their respective foreign currencies and the Indian rupee.

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