CURRENCY SWAP
1. Context
Recently, Japan and South Korea agreed to revive a currency swap agreement for times of crisis, in the latest sign of warming ties as the countries work to smooth over historical antagonisms.
Japanese Finance Minister Shunichi Suzuki announced the agreement after meeting with his South Korean counterpart, Choo Kyungho. It was the first time the two countries have held annual financial talks in seven years, though Suzuki and Choo also met in South Korea in May.
2. About Currency Swap
- A currency swap is a financial agreement between two parties to exchange the principal and interest payments on a loan in one currency for the principal and interest payments on a loan in another currency.
- The two parties essentially agree to swap their debt obligations in different currencies.
3. Working of Currency Swap
- In a currency swap or FX swap, the counterparties exchange gave amounts in the two currencies.
- For example, An American company wants to invest in a project in South Korea. It needs to borrow South Korean Won (KRW), but it can get a better interest rate on a U.S. dollar (USD) loan in the United States.
- The company enters into a currency swap with a South Korean bank.
- The Company swaps USD for KRW with the bank and it agrees to pay the bank interest on the KRW loan. The bank agrees to pay the company interest on the USD loan.
- At the end of the swap, the company swaps the KRW back for USD with the bank.
- The currency swap allows the company to borrow KRW at a lower interest rate than it could have gotten by borrowing directly in South Korea.
- The bank benefits from the swap because it gets to earn interest on the USD loan, which is a higher interest rate than it could have gotten on a KRW loan.
4. About Credit Line
- A credit line is a pre-approved loan that a lender makes available to a borrower.
- The borrower can draw on the credit line as needed, up to a specified limit.
- Credit lines are typically used for short-term financing needs, such as covering unexpected expenses or meeting seasonal demand.
5. How does Credit line works?
- When a borrower opens a credit line, the lender agrees to lend them a certain amount of money.
- The borrower can then draw on the credit line as needed, up to the limit.
- The borrower will typically pay interest on the amount of money they have drawn down, but they will not pay interest on the unused portion of the credit line.
- The borrower must repay the credit line in full, plus any interest that has accrued, by the end of the credit line term.
- If the borrower does not repay the credit line in full, they may be charged late fees or other penalties.
6. Map Work-Japan and South Korea
- South Korea and Japan are neighbouring countries in East Asia.
- Geographically, South Korea is located in the Southern part of the Korean Peninsula, while Japan is an island nation located to the east of the Korean Peninsula.
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- The relations between South Korea and Japan have a long and complicated history.
- The two countries have been trading partners for centuries, but they have also been at war twice.
- The first war between Japan and Korea was in 1592. The Japanese invaded Korea and occupied the country for several years.
- The second war was in 1910 when Japan annexed Korea as a colony.
- Korea remained under Japanese rule until the end of World War II in 1945.
- After the war, Korea was divided into two countries: North Korea and South Korea. The two countries have been technically at war since 1953 when the Korean War ended in an armistice.
- Despite the historical tensions, relations between South Korea and Japan have improved in recent years.
- The two countries have signed several economic and trade agreements and they have cooperated on several security issues.
- However, there are still some areas of conflict between the two countries, such as the issue of Japanese war crimes during World War II.
- These issues continue to be a challenge to improving relations between South Korea and Japan.
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For Prelims: Japan, South Korea, North Korea, World War II, Korean War, Korean Peninsula, currency swap, South Korean Won, credit line, East Asia, Korea Strait,
For Mains:
1. Explain the concept of a currency swap? Describe the working of a credit line and highlight its advantages as a flexible form of borrowing for borrowers. (250 Words)
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Previous Year Questions
1. Which one of the following statements best reflects the issue with Senkaku Islands, sometimes mentioned in the news? (UPSC 2022)
A. It is generally believed that they are artificial islands made by a country around South China Sea.
B. China and Japan engage in maritime disputes over these islands in East China Sea.
C. A permanent American military base has been set up there to help Taiwan to increase its defence capabilities.
D. Though International Court of Justice declared them as no man's land, some South-East Asian countries claim them.
Answer: B
2. Currency swap is a method of (UGC Commerce 2019)
A. hedging against foreign exchange risk
B. speculating in foreign exchange
C. leverage instrument used by cooperative banks
D. mode of payment in international trade
Answer: A
3. "Rapid Financing Instrument" and "Rapid Credit Facility" are related to the provisions of lending by which one of the following? (UPSC 2022)
A. Asian Development Bank
B. International Monetary Fund
C. United Nations Environment Programme
D. Finance Initiative World Bank
Answer: B
4. With reference to the "Look East Policy" of India, consider the following statements (UPSC 2011)
1. India wants to establish itself as an important regional player in East Asian affairs.
2. India wants to plug the vacuum created by the termination of the Cold War.
3. India wants to restore the historical and cultural ties with its neighbours in Southeast and East Asia.
Which of the statements given above is/are correct?
A. 1 only B. 1 and 3 only C. 3 only D. 1, 2 and 3
Answer: B
5. Between India and East Asia, the navigation-time and distance can be greatly reduced by which of the following? (UPSC 2011)
1. Deepening the Malacca straits between Malaysia and Indonesia.
2. Opening a new canal across the Kra isthmus between the Gulf of Siam and the Andaman Sea.
Which of the statements given above is/are correct?
A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2
Answer: B
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Source: Investopedia
