$200 million currency swap: Stepping up in Sri Lanka’s hour of need

In a first for Bangladesh, the country has extended a lifeline of sorts to the beleaguered Sri Lankan economy, offering to top up the island nation's depleting foreign reserves by as much as $500 million.

The global coronavirus pandemic has deprived Sri Lanka, which has $3.7 billion of foreign debt maturing this year, of important sources of foreign currency such as tourism and exports.

Its $4.5 billion tourism industry, which was already reeling from the 2019 Easter Sunday bombings that killed 279 people, was hit particularly hard, while its exports were down about 17 percent in 2020.

At the end of April, Sri Lanka's foreign exchange reserves stood at about $4 billion, which is enough to cover the import bills for three months.

On the other hand, Bangladesh's reserves are hitting a new high each month. At the end of April, reserves crossed the $45 billion-mark for the first time.

The two countries are hoping to enter into a currency swap arrangement, initiated during Sri Lankan Prime Minister Mahinda Rajapaksa's visit to Bangladesh in March for the Golden Jubilee celebrations.

The arrangement would allow Colombo to exchange Sri Lankan rupees for $200 million from the Bangladesh Bank, with the amount rising to $500 million.

The BB board has approved in principal to provide $200 million initially at the meeting on Sunday, according to Md. Serajul Islam, its spokesperson.

The Central Bank of Sri Lanka is expected to return the amount in three months at the interest rate of LIBOR + 2 percent. If the tenure goes up to six months, the interest rate would be LIBOR + 2.5 percent, said Islam, also an executive director of the BB.

LIBOR, the acronym for London Interbank Offer Rate, is the global reference rate for unsecured short-term borrowing in the interbank market and acts as a benchmark for short-term interest rates.

This week, the three-month LIBOR is 0.16 percent and 0.18 percent.

For Sri Lanka, whose public and publicly guaranteed debt is estimated to have increased to 109.7 percent of GDP, this is not the first currency swap agreement it has entered into this year as it desperately looks for hard currency to bolster its reserves.

Earlier in March, it has inked a 10-billion-yuan ($1.54 billion) currency swap with China.

Sri Lanka, whose economy contracted 3.6 percent in 2020, its worst growth performance on record, had sought a $1 billion currency swap agreement with India in September last year.

But India, which had already extended a $400 million currency swap facility two months earlier, declined the request unless the island nation entered into an International Monetary Fund debt programme, which comes with a stringent fiscal consolidation prescription.

Only nine of the 16 IMF programmes in Sri Lanka were completed.

Besides, Colombo is loath to turning to the Washington-based multilateral lender. Over the past 55 years, Sri Lanka has needed IMF bailouts 16 times, second only to Pakistan, which has gone to the IMF 20 times.

Sri Lanka last went to the IMF in 2016, seeking a $1.5 billion extended fund facility.

But that programme came to an abrupt end after the Rajapaksa government came to power in November last year.

Sri Lanka's precarious public finances meant in September last year, Moody's, one of the three major rating agencies, downgraded the South Asian nation's sovereign credit rating by two notches: from "B2" (high credit risk) to "Caa1" (very high credit risk).

Moody's said the South Asian nation would be hard-pressed to secure funding to service its huge foreign debt, which amounts to approximately $4 billion (annually) between 2020 and 2025.

But extending financial help to its South Asian neighbour in its hour of need makes perfect sense to Bangladesh, which is at its wits' end over how to make the best use of its heaving foreign reserves in the face of negative interest rates in the Western world.

Usually, such currency swap arrangements happen between the central banks of a wealthier nation and a not too well-off one, said Ahsan H Mansur, executive director of the Policy Research Institute, a private think-tank.

"The fact that Bangladesh is the one providing the dollars is a good ego booster," he said, adding that Pakistan routinely enters into such agreements.

There are risks involved in such deals.

"There is an exchange rate risk involved, but that is on Sri Lanka. There is a country risk too -- what if Sri Lanka becomes insolvent?"

The sum being lent out is not a small amount, said Mansur, a former economist of the IMF.

"But what Bangladesh is getting is a good rate -- under the current circumstances."