THE RESERVE BANK OF INDIA IS REPORTEDLY in discussions with the United States Federal Reserve to put in place a rupee-for-dollar swap line. If the Fed accedes, this would be a first for India but not for the Fed, which has had temporary and standing swap arrangements with chosen foreign central banks for many decades. With trade and financial transactions overwhelmingly denominated in dollars, governments, firms and households across the world are constantly in need of dollars to settle transactions. Periodically, some governments and firms, especially those not earning adequate dollars from their own exports, face dollar funding shortages. The Fed’s swap arrangements are aimed at providing central banks in partner countries access to dollars to meet demands in their jurisdictions.
Under a swap arrangement between the Fed and a foreign central bank, the latter can access dollar funding in exchange for the domestic currency of the applicant. The swap involves two transactions: the first one is the sale to the Fed of a specified volume of the applicant’s domestic currency for dollars at the prevailing market (spot) exchange rate, and the second one is a buyback on a specified date in the future of the domestic currency with dollars paid by the foreign central bank at the same exchange rate. When the second transaction is completed, the foreign central bank also pays interest at a market-related rate, which depends on the duration for which it has drawn on the swap line.
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