CURRENCY SWAP

CURRENCY SWAP

Subject: Economics

Context: The Central Bank of Sri Lanka (CBSL) settled a $400 million currency swap facility from the Reserve Bank (RBI) of India last week, meeting the terms that the two countries had agreed upon.

Concept:

• A currency swap is a transaction in which two parties exchange an equivalent amount of money with each other but in different currencies.
• The parties are essentially loaning each other money and will repay the amounts at a specified date and exchange rate.
• The purpose could be to hedge exposure to exchange-rate risk, to speculate on the direction of a currency, or to reduce the cost of borrowing in a foreign currency.
• In such arrangements no third country currency is involved, thereby eliminating the need to worry about exchange variations.
• The currency swap agreement will also bring down the cost of capital for Indian entities while accessing the foreign capital market.
• The swap arrangement should aid in bringing greater stability to foreign exchange and capital markets .