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The India-Japan currency swap agreed between the two nations in the third week of October 2018 is a monetary policy that is intended to stabilize the falling value of the rupee as against the U.S. dollar. Foreign currency swaps act as the second line of defence against the falling value of our currency, the first line of defence being the foreign exchange reserves maintained by the Reserve Bank of India (RBI). According to this agreement, India may obtain dollars or yens from Japan in exchange for the rupee where the magnitude of the agreement is 75 billion U.S. dollars. Similarly, Japan may acquire the rupee in exchange for the yen. Although the main reason to enter into such an agreement is to ensure investors from losing further confidence in the Indian economy, this measure is intended as only an emergency backup should a dire scenario of volatile exchange rates occur in the future, where the rupee further plummets in relation to the dollar.

Primarily, currency swaps were an agreement where one party exchanges the principal and interest in one currency with the principal and interest amounts in another currency, thereby obtaining a favourable interest rate in comparison to borrowing from a foreign bank. This policy was first introduced by the World Bank in the 1980s where it sought to secure German marks and Swiss francs. Such swaps are done on loans with long-term maturity such as 10 years or more. The most important reason to engage in a currency swap is to obtain a cheaper source of debt. If a foreign debt is secured, the payback amount will be affected by the volatility of the foreign exchange market. Therefore, a currency swap insures against such volatility. During the entire contractual period of the swap, each party pays the principal amount to the other party until all the principal amount is paid back. Once the payback is completed, the principal amount is again exchanged at a predetermined rate to avoid transaction risks.

However, the agreement between India and Japan is more to do with the prevention of foreign exchange volatility rather than the cost of borrowing or lending a loan. It also ensures that India can turn to the RBI instead of the International Monetary Fund (IMF) if the country runs out of foreign reserves. This measure may save India the transaction costs of acquiring foreign currency from an overseas entity such as the IMF. The previous currency swap agreement with Japan in 2013 was valued at 50 billion U.S. dollars, although, this fund was never utilized to stabilize the rupee. This move will also provide the Indian capital market with a greater access to funds, thereby reducing reliance on the U.S. dollar.

The exchange of rupees and yen may counter the overdependence of India and Japan on the U.S. dollar. In an added bonus, this agreement may facilitate trade between the two countries in their respective currencies instead of the U.S. dollar. Further, India and Japan will repay the 75 billion U.S. dollar amount in the prevailing exchange rate. This will be later be offset by a swap rate called LIBOR (London interbank offer rate) rate, which will be the short-term interest rate between the two nations.

It is not the first time that Japan has entered into such an agreement with another nation (considering the swap agreement between India and Japan in 2013) – China, Malaysia, Indonesia, Thailand and Singapore have had such an agreement with Japan before. A strategic analysis of such agreements, considering that most of them involve Asian countries, is an indication that nations are leveraging different means to counter the financial hegemony of the United States. It is an indication that Asian countries now seek to circumvent the nationalistic economic policies of the U.S. under President Trump by aligning closer with other Asian nations. Also, the U.S. trade wars which impose tariffs on imported goods also raises questions about the U.S. commitment to free global trade.

The volatility of oil prices compounded by the instability in Venezuela has pushed nations to seek better financial options with allies and non-allies alike. However, the relationship between Japan and India is premised on mutual trust and there are many current and upcoming infrastructure projects between the two nations such as the bullet train project between Ahmedabad and Mumbai. The Japan International Cooperation Agency has provided technical assistance for metro rail projects in India and economic relations have been further bolstered by the signing of a Comprehensive Economic Partnership Agreement between Japan and India. India-Japan relations have extended beyond economic interests to include military cooperation and common cultural heritage dating back to Buddhist times. It is only natural then that Japan and India would seek to support each other’s economy through deals such as the currency swap.

The deal between India and Japan has been described as a win-win situation for both nations since there are no counterparty risks involved for either party which are otherwise present under other schemes such as developmental loans and borrowings. The deal also comes at a time when there is disagreement between the RBI and the central government over the nature of lending. The RBI seeks to rid the banking system of bad debt, while the government is keen on ensuring that the loans are easily accessible under various schemes. The government must encourage such currency swap agreements with India’s other partners to ensure that export-import transactions can be settled in their respective currencies instead of depending on the U.S. dollar. The agreement also provides a favourable precedent for any future agreements that may require similar bilateral or multilateral economic actions that need to be taken. As a result, it reduces the volatility of the rupee and provides a stimulus to the Indian economy.

 

References:

ET Bureau (2018, October 30). India, Japan sign $75 billion currency swap agreement. The Economic Times. Retrieved from https://economictimes.indiatimes.com/markets/forex/india-japan-sign-75-billion-currency-swap-agreement/articleshow/66415790.cms

Oberoi R. (2018, October 31). What’s in it for India in $75 billion currency swap pact with Japan. The Economic Times. Retrieved from https://economictimes.indiatimes.com/markets/forex/whats-in-it-for-india-in-75-billion-currency-swap-pact-in-japan/articleshow/66443182.cms

(2018, October 31). Win-win deal. Business Line. Retrieved from https://www.thehindubusinessline.com/opinion/editorial/both-india-and-japan-stand-to-gain-from-their-bilateral-currency-swap/article25382529.ece

Image credit: TIME

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Written By Nishanth Chakkere Ramesh

Undergraduate student of Business Administration and International Relations, with a keen interest in understanding the cause of things.

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