Context: Recently, the Reserve Bank of India (RBI) with the concurrence of the Government of India has decided to put in place a revised Framework on Currency Swap Arrangement for SAARC countries for the period 2024 to 2027.

• The Currency Swap Facility will be available to all SAARC member countries, subject to their signing the bilateral swap agreements.

About the Currency Swap Arrangement for SAARC Countries

• The SAARC Currency Swap Facility came into operation in 2012 with an objective to provide a backstop line of funding for short term foreign exchange liquidity requirements or balance of payment crises of the SAARC countries.

• Under the Framework for 2024-27, a separate INR Swap Window has been introduced for swap support in Indian Rupee.

• The total corpus of the Rupee support is Rs 250 billion. 

• The RBI will continue to offer swap arrangements in US$ and Euro under a separate US Dollar/ Euro Swap Window with an overall corpus of US$ 2 billion.

South Asian Association for Regional Cooperation (SAARC)

• SAARC was established in 1985. 

• Secretariat: It was set up in Kathmandu, Nepal, in 1987. 

• It aims to accelerate the process of economic and social development in its member states through increased intra-regional cooperation.

• SAARC has eight member countries: Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri-Lanka.

About Currency Swap Arrangement

• Refers: Two parties exchange equivalent amounts of two different currencies and trade back at a later specified date.

• Currency swaps are often offsetting loans, and the two sides often pay each other interest on amounts exchanged.

• Currency swaps are over-the-counter (OTC) financial instruments. This means they are not traded on a centralized exchange.

• So far, the Commerce Ministry, Government of India, has finalized arrangements with some 23 countries with whom Indians can trade in local currencies such as Angola, Algeria, Nigeria, Iran, Iraq, Oman, Saudi Arabia, Yemen, Japan, Russia, etc.

• Conducted by: Financial institutions conduct most of the  Foreign Currency (FX) Swap, often on behalf of a nonfinancial corporation.

• Significance: Swaps can be used to hedge against exchange rate risk, speculate on currency moves, and borrow foreign exchange at lower interest rates.

Uses of Currency Swaps

• Institutions use currency swaps for a number of reasons.

• Allow companies to hedge their foreign exchange exposures.

• Help to lower financing costs, as it may be cheaper to borrow in a foreign currency.

• To gain access to a foreign currency. 

• To take advantage of interest rate differentials between two countries.

Limitations of Currency Swaps

• Like any financial instrument, currency swaps possess several limitations and risks.

• Counterparty Risk: It means there is a risk that one of the parties may default on their obligations.

• Complexity: Some financial institutions may find it difficult to use them effectively.

• Significant Associated Costs: There may be significant costs associated with entering and managing the swap agreement, depending on the structure. These costs may be attributed to swap fees and hedging costs.

• Limited Liquidity: It makes it difficult to enter or exit a swap agreement at a favorable rate.