In April 2020, the Central Bank of Sri Lanka (CBSL) formulated a 400-million-dollar currency swap facility with the Reserve Bank of India (RBI) for an initial period of 3 months which was then extended till November 2022 due to the current COVID-19 situation.
Most of us might read this on the news and dismiss it as a mere loan, but currency swap agreements have large impacts on the countries involved, as well as their position in the world. Why did India deny Sri Lanka’s request? Is the SAARC agreement still relevant? Is the “Chinese debt trap” applicable to Sri Lanka? Let’s find out as we uncover the truth behind the currency swap facilities and Bangladesh’s economic rise to power.
What is a currency swap agreement?
Before we dive deep into the details, what exactly is a currency swap facility? A loan? An investment? Actually, in a swap agreement, one country provides money in the form of foreign currencies to the receiving country’s central bank, while the receiving country provides an equivalent amount in its currency to the former. It’s important to note, however, that a swap agreement has predetermined terms and conditions to schedule the date of return, the currency of return, date extensions, etc. In today’s fast-paced world of mass trade, central banks require money in foreign currencies for imports, exports, and direct transactions. So, governments and central banks usually engage in these exchanges to provide short-term liquidity to the receiving foreign counterpart. After the 2008 global financial crisis, more and more countries and central banks are making currency swap deals to boost foreign currency reserves and avoid the Balance Of Payment (BOP) crises. Once the swap deal is formulated, the parties decide a date to swap back these quantities of their two currencies, which for Sri Lanka is 2 years.
Sri Lanka’s state and SL-India Swap deal
Sri Lanka was hit hard with COVID-19, leading to a loss of jobs, funding, and healthcare for its citizens. Tourists had also speedily declined due to the pandemic which is unfortunate as tourism is the third-largest source of foreign exchange money for Sri Lanka. Like many others, the country had also placed import restrictions causing remittances to fall, therefore hindering the financial stability even more. The World Bank had predicted a 2.4% increase in its economic growth for 2020, but due to these unprecedented circumstances, the prediction changed to -3%.
To add on even more pressure to its already daunting situation, Sri Lanka had to repay 2.9 billion dollars of debt to loaning countries in 2020 with its foreign exchange (forex) reserves being only 7 billion dollars at that time. In comparison, India’s forex reserves were $439 billion in April 2020 making them a good candidate for a swap agreement. Although a sizeable portion of Sri Lanka’s debt is owed to China, Ganesh Wignaraja from the Lakshman Kadirgamar Institute believes in other notions as well. Mr Wignaraja co-authored a paper citing a 2018 study on Sri Lanka’s loans and concluded that the country’s debt owed to financial markets is more significant than that owed by bilateral lenders such as China and multilateral lenders such as World Bank and IMF.
Bangladesh’s Economic Rise and the SAARC Framework
The SAARC consisting of Bangladesh, Bhutan, India, Sri Lanka, Maldives, Nepal, Pakistan, and Afghanistan formally adopted a currency swap facility funded by the RBI in November 2012. It was recently revised however to further enhance political and financial stability within the South Asian region. The terms of this deal include a ‘corpus’ or a total sum of money amounting to 2 billion dollars, and the currency withdrawals can be made in US dollars, Euros or the Indian Rupee. This facility extended by the RBI is available to all SAARC nations till November 2022, providing short term liquidity and funding to combat COVID-19 crises and debt repayments. Sri Lanka has used $400 million out of the 2 billion so far, leaving the corpus for the other nations.
The main objective of the organization is to improve the standard of life, promote trade and harvest economic growth in the South Asian regions, proving India’s help to be highly beneficial.
India wasn’t the only one to provide Sri Lanka with financial aid, however. In May this year, Bangladesh shocked us all by finalizing a 200-million-dollar currency swap agreement with Sri Lanka which was highly lauded by the Indian Media. Although it may come as a surprise, this currency swap deal is the result of its rapidly growing economy. In fact, it became the fastest-growing economy in South Asia after it expanded nearly 5.2% in the last two decades.
While many were concerned about Bangladesh not providing for its citizens and dealing with external help instead, it has recently pulled millions out of poverty, even overtaking India’s per capita income. With the Colombo port being the centre of major controversy, Bangladesh provided much-needed relief and further deepened their ties with their neighbour.
The SAARC framework has been criticized highly for not living up to its objectives, but situations are starting to look up as bilateral deals are forming, and inter-relations are increasing. Dhaka’s medical and financial assistance marks the rise of a new tiger in the Asian economy.