• The Reserve Bank of India (RBI) has entered into a currency swap agreement with the Maldives Monetary Authority (MMA) under the SAARC Currency Swap Framework 2024-27.

• Under the agreement, the MMA is eligible for financing support from the RBI amounting to $400 million under the US Dollar/Euro Swap Window and Rs 30 billion (Rs 3,000 crore) under the INR Swap Window.

• The agreement would be valid till June 18, 2027.

• The SAARC Currency Swap Framework came into operation on November 15, 2012, to provide a backstop line of funding for short-term foreign exchange liquidity requirements or short-term balance of payments stress till longer term arrangements are made.

What is a Currency Swap Agreement?

• The term “swap” means exchange.

• A currency swap between two countries is an agreement or contract to exchange currencies (either the countries’ own currencies or any hard currency) with predetermined terms and conditions.

• Currency swaps are often conducted between two central banks.

• For a central bank like the RBI, the main purpose of a currency swap is to obtain foreign currency from the issuing foreign central bank under predetermined conditions (such as exchange rate and currency volume).

• In addition to supporting the domestic currency and foreign exchange market, another key purpose of a currency swap is to maintain the value of the foreign exchange reserves held by the central bank.

What is the purpose of currency swap?

• The primary purpose of currency swaps is to avoid turbulence and risks in the foreign exchange market and exchange rates.

• Central banks and governments engage in currency swaps with foreign counterparts to ensure adequate foreign currency during times of scarcity.

• Both central banks and governments work towards this objective using similar mechanisms.

• Turbulence often occurs when a country faces foreign currency scarcity, which can lead to a currency crisis and steep depreciation of the domestic currency.

• In such scenarios, if the central bank or government (e.g., the RBI/government of India) can obtain sizable foreign currency by exchanging domestic currency, it ensures the availability of foreign currency.

• This helps avoid turbulence in the foreign exchange market, depreciation of the domestic currency, and currency crises.

Beyond currency or exchange rate stability, currency swaps between governments have supplementary objectives such as:

i) Promoting bilateral trade.

ii) Maintaining the value of foreign exchange reserves with the central bank.

iii) Ensuring financial stability by protecting the health of the banking system.

• It is desirable for developing countries like India to reach currency swap agreements with countries like the USA, UK, EU, and Japan, whose currencies are hard currencies used in international trade.

• Currency swap agreements can be bilateral or multilateral. The earliest currency swap was between the US Federal Reserve and the Central Bank of France, signed on February 28, 1962.

Currency swap agreements are usually categorised into five types based on the nature and status of the currencies swapped:

i) Exchange cash for cash vs cash for securities.

ii) Exchange conditional vs unconditional swaps.

iii) Exchange reserve currencies on both sides.

iv) Exchange reserve currency for non-reserve currency.

v) Exchange non-reserve currencies on both sides.

(The author is a trainer for Civil Services aspirants.)