Indo-Japan currency swap accord: Prime Minister Narendra Modi’s move will boost forex reserves, support rupee

There have been talks of shoring up the forex reserves of the country and the concept of a non-resident Indian (NRI) bond or a sovereign bond has made its ubiquitous rounds in the discussion rooms. While forex reserves are still comfortable at $393 billion covering over nine months of imports, there is still concern that it has dipped from $425 billion in March 2018. The pressing of the panic button has caused this talk on raising a big amount of dollars through a bond. The government and the Reserve Bank of India (RBI) have in the last month or so announced several measures to increase capital flows and control imports. But they have not really worked. It is in this context that the present arrangement with Japan should be viewed. The Government of India has, however, struck a masterstroke at this stage which has been combined with Prime Minister Narendra Modi’s visit to Japan. A swap arrangement has been negotiated with Japan for $75 billion. The precise terms are not yet in the open but it is important to understand how this works. [caption id=“attachment_4038861” align=“alignleft” width=“380”]  File image of Narendra Modi and Shinzo Abe. Reuters[/caption] A forex swap arrangement, especially with Japan, is not new. Japan has several such arrangements with countries like China, Thailand, Singapore and Malaysia. In fact, we also had a similar arrangement in December 2011. Under such agreements, both the countries agree to lend either dollars or the other currency to one another which is repaid after a period of time. In this case, it is one where Japan will lend dollars to India up to $75 billion over a period of time on tap. Normally it would be three years. India will get this at a pre-decided exchange rate and deposit rupees with Bank of Japan. At the time of redemption, the cost of the dollar will remain the same and hence there is no exchange risk. However, Japan will charge a swap rate which can be linked to LIBOR (2.5 percent for three months or 3 percent for one year) or a domestic rate which can be much lower. As interest rates are low in Japan, it becomes an interesting country to seek such swap arrangements. When the currency is dollar then it is more likely it gets linked with the LIBOR (London Inter-bank Offered Rate). As far as we are concerned, there is a tap of $75 billion which can be used any time by the government. One assumes the government will borrow and return the dollars and pay the cost. If one may recollect that when the swap on FCNR (Foreign Currency Non-Repatriable account) deposits was reckoned in the last episode of currency run in 2013, the rate was 3.5 percent. It may be assumed that the rate will be the same now.

The channel of use of funds is that the government would pick up $75 billion (or the RBI) and then lend the same to banks with probably this cost added to the interest rate. This would still be a good bet for the bank especially if one expects the currency to fall further. In fact, this may be lent to the OMCs (oil marketing companies) directly which would find it beneficial.

The benefit is that these funds are available on tap which means anytime and is normally for short-term purposes which makes it attractive. While in the past such a memorandum signed did not lead to actual borrowings, it provides a cushion of strength to the economy. With the CAD (current account deficit) going up and FPIs (foreign portfolio investments) moving out relentlessly, this is one way of providing support to the rupee to the extent that the fall is due to fundamentals. The market should be happy with this arrangement and it will be interesting to see how the rupee behaves in the next few sessions. The speculative forces certainly would be put to rest. The timing of such a move could have been driven by any of these factors. First, there is a general concern that the forex reserves are falling and the fact that the RBI is selling dollars which has led to depletion of reserves raises a red flag. Second, maybe the situation is not grave but this is a sentiment boosting measure and there is no need for any further conjectures about NRI bonds. The fact that $75 billion is large should assuage markets. Third, it may be purely a political package where the PM has had several rounds of talks on investment by the two countries and building such a cushion was one part of the overall package which was a logical corollary. The swap facility with Japan is definitely a big positive for the forex market and a positive step in firming up the rupee and should be read well by the participants. The external factors of trade wars, crude oil prices, ban on trade with Iran or higher Fed rates would still exert pressure on the rupee, but frankly there is not much that can be done here. The actual impact will soon be felt in the next couple of trading sessions. (The writer is Chief Economist, CARE Ratings; and author of Economics of India: How to fool all people for all times)