Currency Swap facility

Why in news?

• Bangladesh’s central bank has approved a $ 200 million currency swap facility to Sri Lanka.

About Currency Swap:

• A currency swap is a transaction in which two parties exchange principal and interest in different currencies.
• Companies doing business abroad often use currency swaps to get more favorable loan rates in the local currency than if they borrowed money from a local bank.
• For example, if Sri Lanka borrows Rs 100 from India and promises to repay Rs 100 in Indian currency but interest in dollars or vice versa, both parties benefit by hedging against interest rates.
• In this context, a currency swap is effectively a loan that Bangladesh will give to Sri Lanka in dollars, with an agreement that the debt will be repaid with interest in Sri Lankan rupees.
• For Sri Lanka, this is cheaper than borrowing from the market, and a lifeline and will help it to maintain adequate forex reserves during the repayment of its external debts.
• It reduces the risk of exchange rate changes and also reduces the interest rate risk.

PRELIMS QUESTION

Consider the following statements regarding Currency Swaps:
1.It can only be used by Governments and not Companies.
2.It tends to reduce interest rate risks for participating countries.
Which among the above statements is/are correct?
(a)1 only
(b)2 only
(c)Both 1 and 2
(d)Neither 1 nor 2

  Answer to prelims question