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Currency Swaps
A currency swap is a financial agreement between two parties to exchange principal and interest payments in different currencies for a specified period. It is often used by multinational corporations, banks, and governments to hedge foreign exchange risk, reduce borrowing costs, or obtain foreign currency funding.
- Principal Exchange: At the start, the parties exchange an equivalent amount of money in different currencies based on the current exchange rate.
- Interest Payments: During the agreement, each party pays interest in its respective currency. The interest rate can be fixed or floating.
- Final Principal Exchange: At the end of the swap, the principal amounts are exchanged back at the pre-agreed rate.
- Fixed-for-Fixed Swap: Both parties pay fixed interest rates in different currencies.
- Fixed-for-Floating Swap: One party pays a fixed rate while the other pays a floating rate.
- Floating-for-Floating Swap: Both parties pay floating interest rates based on different benchmarks (e.g., LIBOR, SOFR, EURIBOR).
- Hedging: Companies with international operations use currency swaps to manage exchange rate risk.
- Lower Borrowing Costs: A company can borrow in a currency with lower interest rates and swap it into the desired currency at favorable terms.
- Foreign Investment: Investors use currency swaps to finance international projects without exposure to currency fluctuations.
A USD-INR currency swap is an agreement between two parties (such as the Reserve Bank of India (RBI), banks, or corporations) to exchange U.S. dollars (USD) and Indian rupees (INR) at a predetermined exchange rate for a specified period. These swaps help manage currency risk, stabilize forex reserves, and optimize borrowing costs.
How a USD-INR Currency Swap Works
- Initial Exchange:
- Party A (e.g., an Indian company) borrows USD from Party B (e.g., an American bank).
- Party A provides an equivalent amount in INR at the prevailing exchange rate.
- Interest Payments:
- Throughout the swap tenure, both parties pay interest in their respective currencies.
- The interest rate can be fixed or floating (e.g., based on LIBOR, SOFR, MIBOR, etc.).
- Final Exchange (Maturity):
- At the end of the swap period, the principal amounts are re-exchanged at the pre-agreed rate, regardless of the current market exchange rate.
Bilateral Currency Swap - Between two central banks (e.g., RBI and the Federal Reserve) to stabilize forex reserves.
Commercial Currency Swap - Between banks or corporations for hedging or lowering borrowing costs.
Key Benefits of USD-INR Currency Swaps
Hedging Against Exchange Rate Fluctuations - Protects against USD-INR volatility.
Lower Borrowing Costs - Indian companies can borrow USD at lower rates and swap it into INR.
Forex Reserve Management - RBI uses swaps to manage USD liquidity in the Indian economy.
Trade & Investment Facilitation - Helps businesses engaging in USD-INR transactions.
Example of a USD-INR Currency Swap
Suppose Company X (India) wants to raise USD 10 million for a U.S. project but finds USD loan rates high. Meanwhile, Company Y (U.S.) needs INR for an Indian expansion.
- They enter a swap agreement:
- Company X provides INR 830 crore (assuming 1 USD = ?83).
- Company Y provides USD 10 million.
- Interest payments: Each company pays interest in its home currency.
- Final exchange: After the agreed period, they return the principal at the pre-agreed exchange rate, avoiding forex risk.