Home ›› 30 Jan 2022 ›› Editorial
Simply speaking, a swap means exchange. You get a blue marker in exchange for my red marker. However, a currency swap indicates the exchange of one currency in lieu of another currency that yields a win-win situation for both entities. Swap arrangements may be between two countries, between two multinational companies, or even between a multinational company and a multilateral donor agency. Currency swap is a convenient way to get one currency for another currency when one entity needs the currency of another entity when the mutual currency transaction involves a reasonable cost or there may be capital control.
The first formalised swap agreement in 1981 was between IBM and the World Bank; when the World Bank with excess dollar reserves needed to borrow German Marks and Swiss Francs to finance its operations, but the governments of those countries imposed capital control. IBM who borrowed large amounts of those currencies needed dollars to invest as the interest rates in the USA were high for corporate borrowers. Here, IBM swapped its borrowed currency Francs and Marks for the World Bank’s dollars and fenced the currency exposure through the higher corporate interest rate of dollars. A foreign exchange swap or FX swap is thus a simultaneous purchase and sale of two different currencies with in-built hedging mechanisms to safeguard mutual interest in the transaction process. The swaps on many occasions have been used by central banks to boost reserves that were subsequently lent to the domestic banks to protect the currency value or service the outstanding debt. Intelligent matching of currency value fluctuations with the interest rate margin is crucial in the whole transaction process.
However, the honesty of such a mutually convenient financial transaction may be baffled in the event of a central bank reluctance or unwillingness to honour the terms of agreements.
Recently, Bangladesh extended the credit facility amounting to $200 million in three tranches under a currency swap deal with Sri Lanka. The Bangladesh Bank [BB], the central bank of Bangladesh released $50 million as the first tranche on August 19, 2021, $100 million on August 30 as the second tranche, and the final installment worth $50 million was released on September 21, 2021. Bangladesh would receive two per cent plus LIBOR as interest on the credit amount, the applicable interest would be 2.5 percent in the event of default after six months. The swap initiative is considered as a friendly gesture of Bangladesh towards her neighboring country ladened with debt and currently with inadequate reserves in servicing the existing debt. The initiative was taken after Sri Lankan Prime Minister Mahinda Rajapaksa’s visited Bangladesh in the celebrations of the Golden Jubilee of Bangladesh’s independence. Bangladesh’s foreign exchange reserve stood at $48 billion on August 24, 2021, following $ 1.45 billion financial assistance from the IMF. If the Central bank of Sri Lanka [CBSL] fails to return the money, the Sri Lankan government will pay back the loan as per the state guarantee attached in the agreement. As per the deal, the CBSL handed over an equivalent amount of its currency, around 49.5 billion Lankan rupees that BB keeps in a South Asian Bank, and subsequently defray import bills to the tune of $50-55 million a year. Currently, this is the most preferred investment option.
When we look into the whirlwind of debt nexus, the ambivalence of Sri Lanka in the tug of war is imminent among the three major donors; China, India, and the IMF. China makes up over 15 per cent of the total debt and the loan was advanced to enrich the infrastructure that included the development of Colombo's Hambantota International Port, also known as the Magampura Mahinda Rajapaksa Port. India offered credit and foreign exchange support worth $ 500 million line of credit for fuel purchase to show its commitment towards Sri Lanka’s economic growth. A member of IMF from August 1950, Sri Lanka obtained IMF finance for the first time in 1961, and then in 1962, within the reserve trenches. However, the discordant relationships with the IMF may be one of the reasons for this debt ordeal. The reluctance to approach the IMF in 2009 amid the global financial crisis and reliance on friendly governments is considered by critics as dubious regarding the perilous state of the economy. Sri Lanka did not like the austerity measures prescribed in the IMF approach. “Well, we don’t need relief if we have an alternative strategy.”
This statement by Ajith Nivard Cabraal, Sri Lanka’s central bank governor on January 24, 2022 manifests reliance on government-to-government approach solutions through the central banks’ intervention. However, the cumulative debt approaching the threshold of GDP is an omen in international borrowing as donors are reluctant to lend due to poor ratings by international credit rating agencies. Moody’s investor’s service downgraded the country two notches from B2 and Fitch Ratings has downgraded Sri Lanka's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CC', from 'CCC', suggesting imminent default to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources.
Sri Lanka was a model for replication in the development process for many LDCs and developing countries during the 1980s for her basic needs philosophy of growth. Unfortunately, a nearly three-decades-long civil war [July 23, 1983- May 18, 2009] devastated the economic fundamentals; nevertheless, with a GDP of $ 5.17 billion in 1983 [per capita incomes of $ 329] ; GDP reached $ 48 billion with per capita income of $ 2400 in 2009. During the next decade, the GDP reached its zenith in 2018 at USD 88 billion with a per capita income of $ 4050. The impact of the Covid-19 pandemic has been devastating on the economy that contracted by 3.4 percent during 2020. Tourism, the mainstay of the economy, suffered significant losses in foreign exchange earnings. Revenue from tourism dropped by $ 3 billion over the eight months of 2021 and benchmark inflation accelerated to 14 percent in December from 11 per cent in November, 2021. The implied lesson from this dire experience of Sri Lanka manifests that sound macroeconomic management rests on sound political and economic institutions. Perhaps, the ruling elite is failing to ensure the sanctity of these institutions through appropriate strategies and policies that led to this perilous state of the economy.
The writer is the Treasurer and Professor at the School of Business and Economics, United International University. He can be contacted at obaidur@ eco.uiu.ac.bd.
