ECONOMYNEXT – Entering into foreign exchange swaps, was one of the ways endorsed by the International Monetary Fund for Lanka’s central bank to build reserves, an official said.
Sri Lanka busted all its reserves and also ‘reserves’ borrowed through swaps to suppress interest rates and enforce its bureaucratically decided policy rate during the last currency crisis.
“Rebuilding reserves is a very important component of the IMF supported programs,” Deputy Mission Chief for Sri Lanka Katsiaryna Svirydzenka.
“One, is what we call organic purchases by the central bank in the foreign exchange market.
“The other one is rebuilding reserves for engaging with swaps.
“This can either be swaps with domestic banks, but also swaps with other central banks. The latter is a very important part of both global and regional financial safety nets.”
Central bank swaps were invented by the Fed in the 1960s when the US dollar came under pressure due to ‘macro-economic policy’ where rates were suppressed with open market operations leading to less activist European central banks demanding US gold reserves.
Using reserves and sterilizing the intervention (offsetting the reserve sales with newly printed rupee reserves into banks by repurchasing government debt in their balance sheets) allows an IMF-prone central bank to delay a correction in the interest rate and domestic credit.
Raising dollars through swaps allow a reserve collecting central bank to maintain a bureaucratically decided ‘rate cut’ beyond its actual foreign reserves and get into debt.
In the last currency crisis, Sri Lanka’s central bank ended up with negative foreign reserves (minus net foreign assets) of about 4.5 billion US dollars after using swap proceeds and borrowings from the Reserve Bank of India to delay a correction in domestic credit.
Some East Asian central banks (which do not customarily acquire domestic assets), use fx swaps to alter bank reserves and provide short term liquidity.
Unlike an ‘organic’ purchase of dollars, which are bought outright, dollars temporarily acquired by the central bank from commercial banks through a swap transaction have to be returned to the counterparty at the end of the contract at the same exchange rate.
Swaps also allow inflationist macro-economists to inject domestic money below the transparently declared polity rate into banks, (depending on the dollar cost of the commercial bank in question) with the exchange rate risk under-written by the central bank, critics say.
If the dollars are used, a negative open position is created in the books of the central bank.
Compared to 4.5 billion US dollars of gross foreign reserves reported by Sri Lanka’s central bank by January 2024, 3.29 billion dollars were encumbered by swaps.
A 1.5 billion US dollar equivalent in Chinese swap was not allowed to be used by the People’s Bank of China, saving the country from further monetary instability and central bank debt.
Regardless of the new swaps, the net negative position in foreign assets has been brought down to about 2.34 billion US dollars by January 2024 with the use of deflationary policy from around 4.5 billion US dollars during the crisis. (Colombo/Mar24/2024)
