The buzz word these days is “currency swap” which seems to be the only pill to treat volatility in the rupee. Ever since Commerce and Industry Minister Anand Sharma talked of the possibility of trading in local currencies during the Board of Trade meeting, more people have been wanting to know what it is all about and how it will impact India’s trade with such countries.
While many countries, in the past, have attempted trade in local currencies on a bilateral basis, no study is available in the public domain to evaluate the impact of such trading arrangement on the volume of trade between the two signatories. In such an agreement, two countries opt for currency swap in their local currencies for a specified tenure. The objective includes promotion of bilateral trade and facilitation of direct investment between the two countries in respective local currencies. Such arrangements give a positive signal to the market on the availability of liquidity of the other country’s currency in the onshore market.
Dollar demand will dip
In actual practice, once currency swap is established, for instance, between India and another country, the exporter will borrow in the currency of importer, sell the currency against the rupee and utilise the rupee for its local operations.
On the due date of contract, the exporter will receive the currency of importer from the buyer and pay off the importing currency locally. Same concept will
Therefore, entering into a currency swap will definitely reduce the demand for dollars, particularly when such arrangements are worked out with countries with whom a large trade deficit exists. From that perspective, India can look for such arrangements with China, Saudi Arabia, Iraq, Indonesia, Kuwait, Qatar, Australia and Venezuela, etc., with whom we are running a trade deficit of $10 billion plus.
Even in the case of these countries, we can give priority to those from whom investment is expected in India so that the swap could also be utilised for encouraging such investments as well.
However, one has to be careful to see that such swap agreements, if with many trading partners, terminate at sizable intervals so that no adverse impact is witnessed when they mature. One of the flaws of a local currency settlement mechanism is that it may accentuate trade deficit with a partner country if the domestic industry is not competitive.
Internationalisation
In most swap arrangements, the exchange rate is determined and a fixed exchange rate may provide impetus to imports, particularly when other currencies are depreciating.
However, whether the deficit increases the overall trade deficit or simply shifts imports from countries which are outside the swap mechanism to countries which are under the swap mechanism needs to be examined closely.
One cannot draw a parallel with the Rupee Trade Arrangement which we have worked out with Iran as that arrangement is in a specific situation and can be treated as a one-way swap. Its experience cannot be a guiding factor for bilateral swap arrangements.
The major benefit from direct convertibility of the currencies is the reduction in transaction and hedging costs it would facilitate by removing the necessity of involving a third currency, generally the US dollar, in foreign exchange transactions. Such mechanisms do provide a stable regime to importer and exporter helping them to concentrate on factors other than currency risk.
One distinct advantage of the swap is greater recognition of currencies involved in such transactions. Therefore, currency swap in the rupee with our counterparts will help in internationalisation of the rupee.
This has prompted China to enter into currency swap agreements with over 25 countries. China feels that these arrangements will not only help in internationalisation of the yuan but will also increase its clout in the region.
Since this would be a new mechanism where we hardly have any experience in the past, it is better that it is implemented in a gradual way, starting with one or two countries on a pilot basis and based on experience so gained, it may be later extended to other identified countries.
(The author is President, FIEO)