What’s in the news?
- India has confirmed a $400 million currency swap with Sri Lanka while deferring another $500 million due for settlement to the Asian Clearing Union (ACU), in a move aimed at helping the island nation witnessing an unprecedented economic crisis.
- India’s assistance follows a request from Sri Lanka during Finance Minister Basil Rajapaksa’s visit to New Delhi in December, for emergency financial assistance, including Lines of Credit for importing essentials and a currency swap to boost Sri Lanka’s draining foreign reserves.
- Sri Lanka is facing a severe dollar crunch that economists say might lead to a default on external debt and create a food shortage in the imports-reliant island nation. Colombo must service over $7 billion outstanding debt in 2022, including bond repayments of $500 million in January and $1 billion in July.
- The Central Bank of Sri Lanka has expressed confidence about paying off the foreign debt.
- In July 2020, the RBI extended a similar swap facility — of $400 million — to help Sri Lanka cope with the impact of the first wave of the pandemic, and later provided a three-month roll over until February 2021, when the Central Bank of Sri Lanka settled it.
- The recent announcement on RBI assistance includes deferring the payment of $500 million that Sri Lanka owes to the ACU, a regional initiative with the Central Banks and Monetary Authorities of Bangladesh, Bhutan, India, Iran, Maldives, Myanmar, Nepal, Pakistan and Sri Lanka.
Leveraging Trinco deal
- Significantly, India’s confirmation of the swap comes a week after the two countries signed a long-pending agreement on jointly developing the strategically located Trincomalee oil tank farm along the north-eastern coast of the island.
- Diplomatic sources had earlier indicated that any financial support from New Delhi to Colombo would have to follow the signing of the deal.
- While RBI’s assistance seeks to help Sri Lanka meet its immediate challenge, the Trincomalee project has long-term implications both, in terms of investment from New Delhi and its strategic interests in the Indian Ocean.
- Apart from the obvious potential for storage in Trincomalee, the recent agreement gives both countries an opportunity to elevate “transactional” ties to a more “strategic level”.
What are currency swap arrangements?
- In the swap arrangement, generally a country provides dollars to a foreign central bank, which, at the same time, provides the equivalent funds in its currency to the former, based on the market exchange rate at the time of the transaction.
- The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even two years later, using the same exchange rate as in the first transaction.
- The RBI also offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion.
- This facility originally came into operation on November 15, 2012 to provide a backstop line of funding for short-term foreign exchange liquidity requirements or balance of payment crises until longer term arrangements were made.
- Under the facility, RBI offers swaps of varying sizes in US Dollars, Euro or Indian Rupee to each SAARC member country depending on their two months import requirement.
- India also has a $75 billion bilateral currency swap line with Japan, which has the second highest dollar reserves after China.
Advantages of such arrangements
- These swap operations usually carry no exchange rate risk, as transaction terms are set in advance. The absence of an exchange rate risk is one of the major benefits of such a facility.
- This facility provides the country, which is getting the dollars, with the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.