Context:

Sri Lanka is “banking on” a $1 billion currency swap from India to meet its debt repayment obligations in 2021 and tide over the current economic crisis, a senior official of the Central Bank of Sri Lanka said.

Relevance:

GS-II: International Relations (India’s Neighbors, Foreign Policies and Developments affecting India’s Interests), GS-III: Indian Economy

Dimensions of the Article:

  1. What is a Currency Swap?
  2. How a Currency Swap Works
  3. About Sri Lanka’s Current position on Debt servicing

What is a Currency Swap?

  • A currency swap is a transaction in which two parties exchange an equivalent amount of money with each other but in different currencies.
  • The parties are essentially loaning each other money and will repay the amounts at a specified date and exchange rate.
  • The purpose of a Currency Swap exercise could be to:
    1. Hedge exposure to exchange-rate risk,
    2. Speculate on the direction of a currency, or
    3. Reduce the cost of borrowing in a foreign currency.

How a Currency Swap Works

In a currency swap, or FX swap, the counter-parties exchange given amounts in the two currencies.

Example for Understanding Currency Swap between 2 countries

  • During a Currency Swap deal, say the U.S. might receive 100 million British pounds (GBP), while the U.K. receives $125 million. This implies a GBP/USD exchange rate of 1.25.
  • At the end of the agreement, they will swap again at either the original exchange rate or another pre-agreed rate, closing out the deal.
  • 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.
  • These swap operations carry no exchange rate or other market risks as transaction terms are set in advance.

Click Here to read about India – Sri Lanka debt relations and Sri Lanka’s Approach to India for Currency Swaps

About Sri Lanka’s Current position on Debt servicing

  • For Sri Lanka, Currency Swap 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.
  • Sri Lanka has already serviced part of its debt in 2021 and is preparing to repay the remaining more than $3 billion debt by the end of 2021.
  • With an international sovereign bond maturing soon, a $1 billion repayment is due in July.
  • Sri Lanka is expecting a $400 million swap from the Reserve Bank of India in a couple of months through the SAARC facility but the additional $1 billion is going to be crucial for Sri Lanka.
  • While official sources in New Delhi earlier indicated that negotiations on the issue were “ongoing”, the Indian government is yet to respond to requests of currency swap as well as the 2020 request for a debt freeze, even as bilateral talks have continued at high levels.
  • Sri Lanka’s gross official reserves currently stand at $4 billion, excluding the “standby” about $1.5 billion swap agreement with the People’s Bank of China.
  • There is also the Currency Swap deal with Bangladesh that 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.

-Source: The Hindu

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