The government and the Reserve Bank of India (RBI) are boosting their financial firepower, preparing for any sudden reversal in capital flows in the weeks and months ahead, which could send the rupee tumbling again.
As part of this, the Indian and the Japanese governments on Friday agreed to enhance the bilateral swap agreement (BSA) from $15 billion to $50 billion.
Japan, which has foreign exchange reserves of over $1.25 trillion, has signed similar currency swap pacts with the Philippines, Indonesia and South Korea.
Under this swap arrangement, both the countries can swap their respective domestic currencies for dollars to meet short-term liquidity mismatches.
“For any economy, drawing down of its FX reserves is usually the first line of defence against external funding problems. BSAs tend to usually be more of a second line of defence as access to such a facility is often seen as a precursor to approaching the IMF,” said Nomura Securities in a note, adding that the agreement should enhance the country's ability to address the market stress.
Finance ministry sources told FE that according to the agreement, the country borrowing dollars will pay interest at Libor + 150 basis points. The borrowing tenure is of three months (90 days), and as per the pact, seven extensions are allowed. The borrowing country will also have to pay a stipulated penalty in case of a default.
“The pact is a safety net. It will be used only if the forex reserves fall below the comfort level,” a finance ministry official said. The central banks of the two countries will take a call on when to use the pact.
In 2008, Indian and Japan had first signed a $3-billion currency swap agreement, but this limit was unused. Against the backdrop of the euro zone crisis in December 2012 and a similar fall in the rupee value against the dollar, both the countries enhanced this limit to $15 billion.
The announcement added to the turn in sentiment on the rupee which rebounded significantly from an intra-day low of 66.30/$ to close at 65.25/$ on Friday, up 1.3% from Thursday's close of 66.11/$. It closed at