Currency Swap Agreement (CSA): Objectives, Features & Significance

A Currency Swap Agreement (CSA) is a deal between two countries or banks where they agree to exchange a certain amount of one currency for another at a fixed exchange rate for a certain period of time. This means they swap the money they use in their countries. For example, one country might give its own currency in exchange for the other country's currency. These nations will repay not only the principal amount owed but also some interest at the end of the term. This allows the country to manage capital movements as well as protect these countries against devaluation of the currency, thus promoting trade with other nations.

In the UPSC (Union Public Service Commission) exam, the topic of Currency Swap Agreements is part of General Studies Paper II, specifically under International Relations and Economic Diplomacy. This topic is important for understanding how countries work together in finance, trade, and how they manage their money to keep their economies stable.

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What is a Currency Swap Agreement?

A Currency Swap Agreement is when two countries or financial institutions agree to exchange their currencies at an agreed-upon rate. These agreements often involve exchanging a certain amount of money and agreeing to pay interest during the term of the swap.

Currency swaps help countries avoid needing to exchange currencies in the global market, where rates can change rapidly. A currency swap occurs if a country, for example, needs a currency such as the US dollar; rather than buying dollars from the market, they can exchange dollars directly with the other country for their local currency. It is also beneficial for countries to have better foreign reserves management and avoid risks of currency conversion.

These agreements are important for ensuring countries have the money they need in case of emergencies or economic troubles, such as during a financial crisis.

Objectives of a Currency Swap Agreement

Currency Swap Agreements have many purposes:

• Stabilizing Currency Reserves: It helps countries to secure sufficient foreign currency to pay the dues arising from important imports or payments.
• Reducing Currency Risks: Avoiding the problems that may arise on account of sudden changes in the currency value by countries.
• Facilitating Trade: It is indeed an easy way to have goods and services traded across the participating countries without having to exchange currencies.
• Building Trust: These agreements manifest mutual trust among the countries, thus strengthening the economic ties.
• Helping with Financial Crises: In times of economic trouble, a currency swap can provide immediate access to foreign currency, helping a country avoid financial problems.

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Some key features of Currency Swap Agreements are:

• Exchange of Principal: At the start, the two parties exchange a certain amount of their currencies.
• Interest Payments: Normally based on the cash amount received during the transaction under the swap, the parties pay interest to each other.
• Fixed Time Period: Generally the swap lasts for a set period, from months to years.
• Exchange Rate Agreement: The currencies are exchanged at a fixed rate, which means the value will not change during the swap.
• Flexibility: The terms of the swap can be changed to suit the needs of the countries involved.

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Significance of Currency Swap Agreements

Currency Swap Agreements are very important because they help countries in several ways:

• Providing Financial Stability: These agreements ensure that countries have enough foreign currency, which helps keep their economy stable.
• Boosting Trade: They make trade easier and cheaper, which is good for the economy.
• Reducing Dependence on Global Markets: Countries don’t have to rely on international markets for currency, which can be expensive and risky.
• Strengthening Relationships: Currency swaps can strengthen relationships between countries, making it easier to collaborate in other areas like business, education, and security.

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India has made several Currency Swap Agreements with different countries. Some of the most important agreements include:

• India and Japan: India and Japan signed a Currency Swap Agreement in 2018 worth 75 billion Japanese Yen. This helps both countries with trade and financial stability.
• India and Sri Lanka: In 2020, India entered into an agreement with Sri Lanka in which up to $400 million would be swappable. This involved assisting Sri Lanka to manage foreign currency requirements during difficult situations.
• India and Maldives: In 2019, India entered into a currency swap agreement with the Maldives that was worth $200 million and temporarily relieved the economic status of the country.

• India and SAARC countries: India has also signed Currency Swap Agreements with all the South Asian countries (SAARC). This agreement provides ways for managing the finances of these countries' residents and supporting trade within the region.

These agreements are part of India’s strategy to help its neighbors and ensure financial stability in the region.

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RBI’s SAARC Currency Swap Framework for 2024-2027

The SAARC Currency Swap Framework has now been renewed by the Reserve Bank of India for the period of 2024 to 2027. The countries in South Asia can, therefore, swap foreign currency of up to $2 billion under this framework. This enables the smaller economies in the region, such as Sri Lanka and Bangladesh, to better manage their finances and mitigate any sudden shocks to the value of their currency.

With this framework, India enables its neighbors to stabilize their economies during times of need, thereby enhancing the relationship between India and other South Asian countries, which would then ease cooperative efforts.

Key Takeaways on Currency Swap Agreement for UPSC Aspirants Definition of Currency Swap Agreement (CSA): A Currency Swap Agreement is a deal between two countries or institutions to exchange a certain amount of one currency for another, usually at a fixed exchange rate, for a set period of time. Objectives of Currency Swap Agreements: The main objectives include stabilizing currency reserves, reducing currency risk, facilitating trade, supporting economic growth, and enhancing financial security. Key Features of Currency Swap Agreements: These include the exchange of principal amounts, interest payments during the term, fixed exchange rates, and a set duration. Significance of Currency Swap Agreements: They help in ensuring financial stability, boosting trade, reducing dependence on global markets for currency exchange, and strengthening economic ties between countries.

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