Currency Swap Facility
- 28 May 2021
- 6 min read
Why in News
Recently, Bangladesh cleared a USD 200 million currency swap facility for Sri Lanka, to help boost its economy.
- The word swap means exchange. A currency swap between the two countries is an agreement or contract to exchange currencies with predetermined terms and conditions.
- In the present 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.
- Central banks and Governments engage in currency swaps with foreign counterparts to meet short term foreign exchange liquidity requirements or to ensure adequate foreign currency to avoid Balance of Payments (BOP) crisis till longer arrangements can be made.
- For Sri Lanka, this is cheaper than borrowing from the market, and a lifeline as it struggles to maintain adequate forex reserves even as repayment of its external debts looms.
- These swap operations carry no exchange rate or other market risks as transaction terms are set in advance.
- Exchange rate risk, also known as currency risk, is the financial risk arising from fluctuations in the value of a base currency against a foreign currency in which a company or individual has assets or obligations.
- Unusual for Bangladesh:
- 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, it has managed to elevate its economy itself majorly, and in 2020, was the fastest growing in South Asia.
- 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.
- Sri Lanka’s Approach to India:
- In 2020, the President of Sri Lanka requested India for a USD 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, which made India put off the decision.
- Earlier, in July 2020, the Reserve Bank of India (RBI) extended a USD 400 million credit swap facility to Sri Lanka, which the Central Bank of Sri Lanka settled in February. The arrangement was not extended.
- RBI’s Framework for Swap Facilities for SAARC:
- The SAARC currency swap facility came into operation on 15th November, 2012.
- The revised framework is valid from 14th November, 2019 to 13th November, 2022.
- The RBI can offer a swap arrangement within the overall corpus of USD 2 billion.
- The swap drawals can be made in US dollar, euro or Indian rupee. The framework provides certain concessions for swap drawals in Indian rupee.
- The facility will be available to all SAARC member countries, subject to their signing the bilateral swap agreements.
- 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.
Balance of Payment
- Balance of Payment (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.
- Overall the BoP account can be a surplus or a deficit.
- If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account.
- If the reserves in the forex account are falling short then this scenario is referred to as BoP crisis.
- Components of BOP:
- Current Account: It shows export and import of visibles and invisibles (includes goods and services).
- Capital Account: It shows a capital expenditure and income for a country. It gives a summary of the net flow of both private and public investment into an economy.
- Errors and Omissions: Sometimes the balance of payment does not balance. This imbalance is shown in the BoP as errors and omissions.
Foreign Exchange Reserves
- Foreign exchange reserves are assets denominated in a foreign currency that are held by a central bank.
- These may include foreign currencies, bonds, treasury bills, and other government securities.
- These reserves are used to back liabilities and influence monetary policy.