Currency swap facility for Sri Lanka

Source: By The Indian Express

Bangladesh’s central bank has approved a $200 million currency swap facility to Sri Lanka. What does this mean and why is it significant?

Bangladesh Bank, Bangladesh’s central bank, has in principle approved a $200 million currency swap agreement with Sri Lanka, which will help Colombo tide over its foreign exchange crisis, according to media reports from Bangladesh, quoting the bank’s spokesman.

Sri Lanka, staring at an external debt repayment schedule of $4.05 million this year, is in urgent need of foreign exchange. Its own foreign exchange reserves in March year stood at $4 million.

The two sides have to formalise an agreement to operationalise the facility approved by Bangladesh Bank. Dhaka decided to extend the facility after a request by Sri Lankan Prime Minister Mahinda Rajapaksa to Bangladesh’s Prime Minister Sheikh Hasina.

What is a currency swap?

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 as is it struggles to maintain adequate forex reserves even as repayment of its external debts looms. The period of the currency swap will be specified in the agreement.

Isn’t it unusual for Bangladesh to do this?

Bangladesh has not been viewed so far as a provider of financial assistance to other countries. It has been among the most impoverished countries of the world, and still receives billions of dollars in financial aid. But over the last two decades, its economy has pulled itself up literally by the bootstraps, and in 2020, was the fastest growing in South Asia.

Bangladesh’s economy grew by 5.2 per cent in 2020, and is expected to grow by 6.8 per cent in 2021. The country has managed to pull millions out of poverty. Its per capita income just overtook India’s.

This may be the first time that Bangladesh is extending a helping hand to another country, so this is a landmark of sorts.

Bangladesh’s forex reserves in May were a healthy $45 billion. In 2020, despite fears that the pandemic would hit remittances, Bangladeshis living abroad sent over $21 billion. It is also the first time that Sri Lanka is borrowing from a SAARC country other than India.

Why didn’t Sri Lanka approach India, the biggest economy in the region?

It did, but did not get a reply from Delhi. Last year, President Gotabaya Rajapaksa knocked on Prime Minister Narendra Modi’s door for a $1 billion credit swap, and separately, a moratorium on debts that the country has to repay to India. But India-Sri Lanka relations have been tense over Colombo’s decision to cancel a valued container terminal project at Colombo Port.

India put off the decision, but Colombo no longer has the luxury of time. With the tourism industry destroyed since the 2019 Easter attacks, Sri Lanka had lost one of its top foreign exchange pullers even before the pandemic. The tea and garment industries have also been hit by the pandemic affecting exports. Remittances increased in 2020, but are not sufficient to pull Sri Lanka out of its crisis.

The country is already deep in debt to China. In April, Beijing gave Sri Lanka a $1.5 billion currency swap facility. Separately, China, which had extended a $1 billion loan to Sri Lanka last year, extended the second $500 million tranche of that loan. According to media reports, Sri Lanka owes China up to $5 billion.

What about last year’s credit swap facility that India gave Sri Lanka?

Last July, the Reserve Bank of India did extend a $400 million credit swap facility to Sri Lanka, which the Central Bank of Sri Lanka settled in February. The arrangement was not extended.

RBI has a framework under which it can offer credit swap facilities to SAARC countries within an overall corpus of $2 billion. According to RBI, the SAARC currency swap facility came into operation in November 2012 with the aim of providing to smaller countries in the region “a backstop line of funding for short-term foreign exchange liquidity requirements or balance of payment crisis till longer term arrangements are made”.

The presumption was that only India, as the regional group’s largest economy, could do this. The Bangladesh-Sri Lanka arrangement shows that is no longer valid.