All you wanted to know about Indo-Japan currency swap

Aarati Krishnan | Updated on: Nov 05, 2018

During his recent visit to Japan, Prime Minister Narendra Modi, apart from discussing bullet trains and yen loans with his Japanese counterpart, also inked a deal for a bilateral currency swap arrangement. While India has such arrangements with many Asian nations, this is among the largest of such deals, valued at $75 billion. The government hopes that this deal will act as a buffer to shore up the rupee, which has depreciated by 14 per cent against the dollar this year.

What is it?

A bilateral currency swap is an open-ended credit line from one country to another at a fixed exchange rate. The country which avails itself of this loan pays interest to the country which provides it, at a benchmark interest rate such as the Libor (London Inter-bank rate).

This currency swap arrangement will allow the Indian central bank to draw up to $75 billion worth of yen or dollars as a loan from the Japanese government whenever it needs this money. The RBI can either sell these dollars (or yen) to importers to settle their bills or to borrowers to pay off their foreign loans. The RBI can even hang on to the money to shore up its own foreign exchange reserves and defend in the rupee. Should the Japanese central bank knock on India’s doors for a $75-billion loan, the RBI too is obliged to provide it at Libor, out of its own reserves.

Why is it important?

In recent times, the rupee has been falling against the dollar because of its widening current account deficit (the difference between imports and exports of goods and services). This leads to importers upping their demand for dollars far beyond what exporters bring into the country.

While the RBI had amassed foreign currency reserves of over $426 billion by April 2018, it has had to use up some of this in recent weeks to prop up the rupee. Though present forex reserves at over $390 billion are still comfortable, having a $75-billion loan-on-demand from Japan gives the RBI an additional buffer to fall back on, should it need extra dollars.

A swap arrangement with Japan provides considerable comfort to India, because Japan is the second largest holder of dollar reserves in the world after China and is sitting on fat coffers of over $1,250 billion. Therefore, while Japan is quite unlikely to ask India for a dollar loan, India can make use of such a loan at rock-bottom interest rates.

But what’s in it for Japan? Well, Japan may see this deal as quid pro quo for lucrative investment deals that help Japanese companies set up shop in India.

China and Japan also use bilateral currency swaps as instruments to fight the hegemony of the dollar, as it coaxes more countries to use their currency to settle their bills.

Why should I care?

Think of how convenient it would be if you had a rich uncle who told you – “I really like you, beta. Anytime you need ₹75 lakh, just ask me and I’ll give you a loan at an ultra-low interest rate.”

Even if your finances were on the brink, you would probably sleep easy knowing that you have this lifeline. Your own credit-worthiness with others would go up a few notches after this deal because everyone knows you have this ₹75 lakh on tap.

Currency swaps between countries work much the same way, except that in a bilateral arrangement, both countries are expected to play rich uncle to each other.

So, will this deal immediately boost the rupee? It may not, because it remains only on paper until India actually asks Japan for the loan.

But it does boost the confidence of importers and investors dealing in the rupee, as they know that there’s a rich uncle waiting in the wings.

The bottomline

Maybe this is a sweeter deal than bullet trains.

Published on November 05, 2018
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