By Shiran Illanperuma/The Morning
Colombo, May 17: In the last year, Sri Lanka has procured U$ 1.9 billion worth of bilateral currency swaps – US$ 1.5 billion from the People’s Bank of China (PBOC), and US$ 400 million from the Reserve Bank of India – as part of the Central Bank’s reserve management strategy.
These arrangements have helped buffer reserves, keep exchange rates in check, and meet debt servicing obligations amid an unprecedented global crisis – the Covid-19 pandemic. Swaps have emerged as a democratic alternative to the IMF which has failed to provide developing countries adequate support.
What is a swap?
A bilateral currency swap is an agreement wherein the Central Banks of two countries exchange an equal value denominated in their respective currencies. This swapped currency is held for the period of the arrangement, usually 1-3 years, during which time it may be used for current account transactions, settling debt, or even conversion to another currency.
At the end of the period agreed upon, both sides must pay back what they borrow with interest. The spot interest rate and settlement exchange rate are determined up front, at the commencement of the agreement. The same rates are used at the point of settlement.
Throughout the period of the arrangement a mark-to-market (MTM) is conducted. This means that probabilities of exchange rate fluctuation are evaluated to forecast the likelihood of one party going bust due to exchange rates fluctuations. This information can be used to enter into a risk mitigation arrangement – such as through opening up a settlement account or exchange rate variant account.
Swap agreements have increased in frequency since the 2008 Global Financial Crisis, and especially after the Covid-19 pandemic. One reason for this is the increasing difficulty in accessing dollars in the open market, especially for many developing countries whose credit ratings have been downgraded in the wake of the Covid-19 pandemic.
China is currently one of the leading countries engaging in bilateral currency swaps. Between 2009 and January 2020, the PBOC entered into 41 bilateral swap agreements, including with Upper Income countries such as the United Kingdom, Canada and Japan. Sri Lanka is one of the few Lower-Middle Income countries that China has entered into a swap agreement with.
China’s practice of signing bilateral swap agreements is in the context of its increasing presence in international trade, making it the largest trading partner for many countries in the world. China’s stimulus packages in the wake of Covid-19 have also created excess liquidity, which the country can siphon out through swap agreements – a win-win situation for countries like Sri Lanka.
With the shock of the Covid-19 pandemic to the global economy in 2020, orthodox fiscal conservatism was promptly thrown out of the window, and growing deficit financing became the new normal. Yet the differing size of stimulus between countries highlighted a kind of global monetary apartheid.
According to UNCTAD, Covid-19 stimulus packages in 2020 amounted to 9.73% of GDP in developed countries, while developing countries could only afford 5.46% of GDP. By April 2021, fiscal stimulus for advanced economies like Japan, the US, Singapore and Sweden amounted to 54.9%, 27.09%, 27.05% and 23.1% respectively.
Faced with these constraints, developing countries like Sri Lanka called for a global debt moratorium, Emergency Assistance from the IMF, and a general allocation of the IMF’s Special Drawing Rights (SDR). But the response from the international community was disappointing.
Where’s my SDR?
SDR is a supplementary reserve asset and a unit of account, which can be exchanged for currencies of IMF member states. Its value is determined by the weightage of a basket of currencies including the US dollar, the Euro, Japanese Yen, Chinese Yuan, and Pound Sterling. The US dollar has the strongest weightage in the basket, and the US treasury has the power to veto any SDR allocation.
In times of crisis, the IMF can release SDR to member states. In April 2020, at the G20 and IMF-WB Spring meetings, the US blocked a proposal for a general allocation of 500 million SDR. India too, egregiously broke ranks with developing countries to back the US.
In July 2020, Governor of the PBOC Yi Gang urged the IMF to reconsider its position and issue a general allocation of SDR, arguing that, “A general allocation of SDRs, which are sometimes called ‘liquid gold’ and can be created with the stroke of a pen, is the missing piece in IMF’s crisis response.”
Gang’s proposal on behalf of developing countries struggling to keep afloat amid an unprecedented pandemic requiring economically devastating lockdowns, was dismissed by Reuters who likened it to a call to “open cash floodgate”.
Over a year after Yi’s proposal, IMF Managing Director Kristalina Georgieva recently said in an interview to Chinese state-media that she was “confident” that SDR allocations up to $ 650 billion would be rolled out by mid-August 2021.
For most developing countries, this relief will be a little too late. The IMF has already alienated itself from developing countries like Sri Lanka by attaching assistance to disastrous neoliberal policy conditionality. The delay in allocating SDR is just another reminder of the biased and politicised nature of the IMF, whose agenda is controlled by the US Treasury.
In the year since the pandemic began, swap arrangements have emerged as a more democratic alternative to politicised IMF bailouts. Swaps allow developing countries to access foreign currency using their own currency as a kind of collateral. This eases the pressure on dollar reserves which can be used for debt servicing. Most importantly, swaps lack conditionality, allowing governments to maintain policy independence and stability.
Swaps are just a start. Moving on from the current global economic crisis will require Central Banks to think beyond conventional monetary and fiscal instruments. Rather than strapping oneself into a policy straitjacket crafted by economic textbooks, Central Banks should find new and creative ways to foster inclusive growth and stability.