The $75 billion bilateral currency swap agreement signed on October 29 between Prime Ministers of India and Japan in Tokyo fired up the Indian stock market on Monday and took the 30-share BSE Sensex about 700 points higher. 

The agreement signaled to the currency market as well as the stock markets that India wasn't without options while dealing with the persisting volatility in the rupee exchange rate versus the US$.

 

Investopedia defines a foreign currency swap as "an agreement to exchange currency between two foreign parties. The agreement consists of swapping principal and interest payments on a loan made in one currency for principal and interest payments of a loan of equal value in another currency.

 

The purpose of engaging in a currency swap is usually to procure loans in foreign currency at more favorable interest rates than if borrowing directly in a foreign market. The World Bank first introduced currency swaps in 1981 in an effort to obtain German marks and Swiss francs. This type of swap can be done on loans with maturities as long as 10 years. Currency swaps differ from interest rate swaps in that they also involve principal exchanges.

 

In a currency swap, each party continues to pay interest on the swapped principal amounts throughout the length of the loan. When the swap is over, principal amounts are exchanged once more at a pre-agreed rate (which would avoid transaction risk) or the spot rate."

 

An official press release stated that "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 currency swap arrangement between Japan and India has been the high point of economic and financial agreements between the two countries, during the visit of the Prime Minister of India. This represents an increase of 50% over the last currency swap arrangement between the two countries. It is indicative of close bonds between the two countries nurtured by the two leaders. As reported, Prime Minister of Japan Shinzo Abe has said that "he is a friend of India forever."

The swap arrangement is expected to bringing greater stability to foreign exchange and capital markets in India.

 

With this arrangement in place, prospects of India would further improve in tapping foreign capital for country’s developmental needs. This facility will enable the agreed amount of foreign capital being available to India for use as and when the need arises.

To encourage investment in infrastructure, RBI will address the resolution on hedging requirement.

 

Policy interest rate in the USA has seen a gradual increase in the recent months. This is one of the causes of the strengthening of the dollar versus other currencies of the world. Strengthening of the dollar is also resulting in the flight of capital from emerging markets to get better-assured returns. Recent months have seen Governments and Central Banks around the world, especially those of emerging economies, are taking various policy measures to address the international situation of dollar appreciation and to improve the availability of foreign capital.

 

To address the issues of outward flow of foreign capital, India has also taken various steps towards containing the Current Account Deficit (CAD) and rupee volatility. It has taken various measures to attract foreign capital which include relaxations in the policy for external borrowings and issuance of offshore rupee bonds (Masala Bonds), review of certain restrictions on FPI investment in debt, hike in customs duty for curtailing imports of non-essential items, promoting exports, financing standing working capital of Oil Marketing Companies by long-term external borrowings etc.