Exchanging forks and spoons
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Was it misleading or confusing? I posed this question to two well-known economists on Wednesday. Today was Thursday and the trio was under the margosa tree having their usual weekly conversation.“What is the significance of currency swaps, what do they mean?” I asked the first economist.
“Well… a currency swap is simply exchanging each other’s currencies and that’s what we are doing in these arrangements with India and China,” he said. Sri Lanka, meanwhile, is also discussing a currency swap with Bangladesh.
“So when we borrow under a currency swap do we have to return the money (which is somewhat of a loan) in that country’s currency or in US dollars?” I asked again.
“The money that was borrowed, say for example from India, has to be returned in Indian rupees because India swapped its currency for our currency,” he said, adding that currency swaps are only possible with India or China because the Sri Lanka rupee is not a tradable currency and since Sri Lanka has strong trading ties with these two countries.
“It is not an exchange involving US dollars though all the government announcements pertaining to currency swaps also give the US dollar conversion rate which could wrongly imply that such a commitment is in US dollars,” he added.
Comfortable with this explanation, I called the second economist for more details on these kinds of arrangements.
“I agree with you that by including in announcements the US dollar conversion in currency swaps involving Indian rupees or the Chinese yuan, it gives a misleading signal that US currency is involved,” he said and went on to explain in simple terms what a currency swap, which also includes an interest component, is.
“Take for example, you are planning a party and are short of forks. You ask your neighbour to lend you some forks and, in turn, give him an equivalent number of spoons. At the end of the party, you return the forks and he does the same with the spoons. Now if you have damaged the forks, you need to replace them with new ones. The currency swap works in similar ways – the two currencies are exchanged and at some point, maybe two or three years later, you need to return the money borrowed in that country’s currency. Since the Sri Lanka rupee is not a tradable currency, our rupee equivalent of India rupees or Chinese yuan is deposited in an account in that country and when we return the loan, that money is returned,” he said. Currency swaps are between the central banks of two countries
He said that it is better to borrow from the IMF than from China under a swap deal, since China links political conditions to such swaps, while the IMF would only push for economic change. It was precisely for this reason that the Central Bank of Sri Lanka in February 2021 quickly settled a currency swap facility from the Reserve Bank of India (RBI) in anticipation of the 10 billion Chinese yuan swap with China which was agreed to, earlier this week.
At the end of the two conversations, I was adequately armed with knowledge on currency swaps. The reality however is that call it what you like – swaps, loans, credit etc. – eventually this is debt the country has to pay at some point. It’s always a ‘rob Peter to pay Paul’ scenario.
The currency swaps, however, will ease the burden somewhat and can be used to pay for imports from those countries. Sri Lanka is also mindful that in the case of a Chinese loan, the debt has to be paid back in US dollars (not yuan) as the loan is given in US dollars, which is not the same as a currency swap.
According to estimates, Sri Lanka needs to pay back a total debt of $6.4 billion this year, made up of $4.3 billion of government debt; $1.3 billion in Sri Lanka development bonds; and the balance from privately-secured foreign loans.
With figures and economic data swirling above me, I thought of taking a break and looked towards the margosa tree and wondered what they were discussing.
“Me avurudde, maha aswenna hondai, mage gamey inna yaluwo kiwwa (This year, the Maha harvest seems to be good according to friends in our village),” said Kussi Amma Sera. “Ehemanang, aei haal mila mechchara wedi (If that is the case, why are rice prices so high)?” asked Serapina.
“Eh, haal mudalalila sahal thoga sangawa thiyaganna hinda-ne. Hingayak ethikarala eva eliyata danne egollanta one kota ne (That’s because the rice mudalalis are stock-piling paddy and releasing it only when they want to, creating a shortage),” noted Mabel Rasthiyadu. The Maha season starts in September and ends by March.
Indeed, according to the Central Bank, rice production this year is set to achieve 2019 levels which is a positive spin on the economy affected by the pandemic.
While the economy seems to be picking up marginally amidst the pandemic, workers’ remittances are and will always be the saving grace. According to the latest data, remittances rose in January 2021 to $675 million, compared to $581 million in the same 2020 month. Despite their contribution, migrant workers are constantly challenged in many ways with many stranded overseas owing to COVID-19. Even though all other export sectors recorded sharp falls last year, it was remittances that helped the economy act as a cushion against any serious fall in foreign exchange earnings.
In January-February 2021, apparel exports fell by 8.08 per cent to $863 million from the same 2020 months, while tea during the same period rose marginally to $213 million from $207 million.
Due to pressure building on the US dollar amidst a shortage, the Central Bank last week had to suspend two circulars in which exporters and banks were directed to convert part of the export proceeds and sell it to the banking regulator. In the period January to March 10, 2021, the rupee recorded a depreciation of 4.9 per cent against the US currency.
Whew… it was a heavy column this week, discussing currency swaps, loans, depreciation and forks and spoons! As I sipped my second mug of tea, I reflected on the latest information from the Central Bank that the economy is on track for a recovery. I only hope this is true.