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4) What do you understand by currency swap? Discuss the pros and cons of currency swap and explain how it acts as a tool for quantitative easing of the Indian economy ?(250 words)

Topic:  Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

4) What do you understand by currency swap? Discuss the pros and cons of currency swap and explain how it acts as a tool for quantitative easing of the Indian economy ?(250 words)

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Why this question:

The question is in the light of recent move of RBI of the currency swap. The article discusses in detail as to how the central bank is using swaps as an indirect tool to loosen monetary policy, and in what ways it could result in an inflationary spurt later.

Key demand of the question:

The answer must provide for a detailed narration of the concept of currency swap, pros and cons and how it functions as a tool of quantitative easing with reference to the recent step taken by Reserve bank of India.

Directive word:

DiscussThis is an all-encompassing directive – you have to debate on paper by going through the details of the issues concerned by examining each one of them. You have to give reasons for both for and against arguments.

Structure of the answer

Introduction:

Shortly narrate the context of the question.

Body:

Answers must discuss the following aspects :

  • In brief define what you understand by currency swap – A currency swap between two countries is an agreement or contract to exchange currencies (of the two countries or any hard currency) with predetermined terms and conditions. Often the popular form of currency swap is between two central banks
  • How does currency swap between countries work? – A currency swap is similar to an interest rate swap, except that in a currency swap, there is often an exchange of principal, while in an interest rate swap, the principal does not change hands. In currency swap, on the trade date, the counter parties exchange notional amounts in the two currencies.
  • What is the advantage of currency swap? – help mitigate the risk of unwanted interest rate fluctuations. For example, It may be more expensive to borrow in the United States than it is in Japan, or vice versa. In either circumstance, the domestic company has a competitive advantage in taking out loans from its home country. Its cost of capital is lower.
  • Context of India’s currency swap – Under the current swap auction, RBI will buy US dollars from banks totaling to $5 billion. Minimum bid size would be $25 million and in multiples of $1 million thereafter.
  • Discuss and list down the benefits and issues associated, take cues from the article.

Conclusion –

Conclude with way forward and state how the RBI’s latest move is in line with its easy monetary policy stance.