Swaps are among a large class of derivative instruments that are superficially easy to understand while being devilishly complex in reality. They started as a convenience. Some businesses want to lock in fixed rates for loans. Others prefer to borrow via floaters.
Say, A wants a fixed rate and B wants a floater. A and B can agree upon a principal amount and a benchmark floating interest rate, for example, the Mibor (Mumbai Interbank Offered Rate). Then, A agrees to pay B a fixed rate, while B agrees to pay a floating rate benchmarked to Mibor to A. Hence, A gains if the floating rate rises, while B gains if the floater drops. The principal is not usually exchanged in a swap. The rate differentials are netted off, with the loser paying the winner at agreed-upon intervals.
The swap allows both A and B to borrow from the market, and manage cash flows the way they prefer. The combined repayment obligation can often be structured to save overall borrowing costs. Same currency swaps are bets on rate movements and might have complex structures. A floater for floater swap, for instance.
In a cross-currency swap, "winning" depends on currency movements and multiple interest rates. It is possible that the swap might reduce combined obligations. For example, A might be able to access lower rupee interest rates and B might have similar dollar rate advantages.
The Reserve Bank of India (RBI) has opened a swap window for Public Sector Undertakings such as BPCL, Indian Oil and HPCL, to help meet their crude oil import obligations. RBI will sell/buy dollar-rupee forex swaps for a fixed tenure through a designated bank (presumably a PSU). RBI (via SBI perhaps) will therefore give dollars to oil PSUs, while the PSUs commit to returning the dollars at a designated time.
By taking crude import obligations "off-market", the swaps defer pressure on the dollar-rupee rate. We don't know the swap terms, the timeframe or how long RBI intends to maintain this facility. We do know that oil PSUs need $12 billion every month at the current crude rates and there will be in exchange of principal.
This has interesting implications. One that somebody is likely to lose from this transaction. It may be the banks or the oil PSUs. It depends on specific terms, the market movements in dollar-rupee and the respective interest rates. Whatever the terms, somebody will lose if there is currency volatility or interest rate volatility and both are likely.
The accounting treatment is complex and opaque. It will not be obvious who loses and how much. Even more important, it won't be possible to judge what the potential losses could be.
This could have gigantic consequences.
Another point: The rupee equivalent of $12 billion per month or more is involved in each set of monthly swaps. The impact on the rupee money supply will depend on what RBI allows the designated bank to do with the money received.
Will those rupees be allowed into circulation or will the RBI "sterilise", by asking the bank to park these in government paper? The latter would further constrict money supply and in effect, expand the quantitative tightening programme by a $12 billion rupee equivalent per month.
Also, to complete each swap, the PSUs must buy dollars at some stage. This will push up the dollar when it does happen. The central bank must be prepared to deal with that. Perhaps RBI will conjure up an "endless" rollover mechanism?
More information about the structure would obviously be useful. It does defer pressure on the open market dollar-rupee rates. But to further this short-term goal, the central bank might have set up a mechanism that could cause a great deal of damage, somewhere down the road.
Say, A wants a fixed rate and B wants a floater. A and B can agree upon a principal amount and a benchmark floating interest rate, for example, the Mibor (Mumbai Interbank Offered Rate). Then, A agrees to pay B a fixed rate, while B agrees to pay a floating rate benchmarked to Mibor to A. Hence, A gains if the floating rate rises, while B gains if the floater drops. The principal is not usually exchanged in a swap. The rate differentials are netted off, with the loser paying the winner at agreed-upon intervals.
The swap allows both A and B to borrow from the market, and manage cash flows the way they prefer. The combined repayment obligation can often be structured to save overall borrowing costs. Same currency swaps are bets on rate movements and might have complex structures. A floater for floater swap, for instance.
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It is more mind-boggling when two currencies are involved. For example, A may pay a fixed rate denominated in rupees to B, and receive a fixed rate in dollars from B. Or A may pay a rupee floater, while B pays a US dollar floater. Or it could be a fixed dollar versus rupee floater, etc.
In a cross-currency swap, "winning" depends on currency movements and multiple interest rates. It is possible that the swap might reduce combined obligations. For example, A might be able to access lower rupee interest rates and B might have similar dollar rate advantages.
The Reserve Bank of India (RBI) has opened a swap window for Public Sector Undertakings such as BPCL, Indian Oil and HPCL, to help meet their crude oil import obligations. RBI will sell/buy dollar-rupee forex swaps for a fixed tenure through a designated bank (presumably a PSU). RBI (via SBI perhaps) will therefore give dollars to oil PSUs, while the PSUs commit to returning the dollars at a designated time.
By taking crude import obligations "off-market", the swaps defer pressure on the dollar-rupee rate. We don't know the swap terms, the timeframe or how long RBI intends to maintain this facility. We do know that oil PSUs need $12 billion every month at the current crude rates and there will be in exchange of principal.
This has interesting implications. One that somebody is likely to lose from this transaction. It may be the banks or the oil PSUs. It depends on specific terms, the market movements in dollar-rupee and the respective interest rates. Whatever the terms, somebody will lose if there is currency volatility or interest rate volatility and both are likely.
The accounting treatment is complex and opaque. It will not be obvious who loses and how much. Even more important, it won't be possible to judge what the potential losses could be.
This could have gigantic consequences.
Another point: The rupee equivalent of $12 billion per month or more is involved in each set of monthly swaps. The impact on the rupee money supply will depend on what RBI allows the designated bank to do with the money received.
Will those rupees be allowed into circulation or will the RBI "sterilise", by asking the bank to park these in government paper? The latter would further constrict money supply and in effect, expand the quantitative tightening programme by a $12 billion rupee equivalent per month.
Also, to complete each swap, the PSUs must buy dollars at some stage. This will push up the dollar when it does happen. The central bank must be prepared to deal with that. Perhaps RBI will conjure up an "endless" rollover mechanism?
More information about the structure would obviously be useful. It does defer pressure on the open market dollar-rupee rates. But to further this short-term goal, the central bank might have set up a mechanism that could cause a great deal of damage, somewhere down the road.