COLOMBO – A swap with the People Bank of China is to be extended for another three years from 2024, according to documents released with the approval of a deal with the International Monetary Fund (IMF).

“…[T]he PBoC has indicated that it will consider renewing its swap arrangement with the CBSL in 2024 for another three years, if there is no significant situation change,” the program documents stated..

According to projections in the IMF program, a 200 million dollar swap with the Bangladesh central bank is expected to be repaid in 2023. A 400 million US dollar swap with the Reserve Bank of India is to be repaid in 2024.

Central bank swap lines of the type was invented by the Fed in the 1960s when it was printing too much money to suppress interest rates and threatening the exchange rate, which was pegged at 35 dollars an ounce of gold..

Charles Coombs, head of the foreign exchange desk at the Federal Reserve Bank of New York, is credited with inventing the swaps to avoid returning gold to the European central banks.

In the run up to the collapse of the US dollar in 1971-72 moves to expand swaps was resisted by some European banks as it was viewed as a tool by Fed to “prop up the dollar” and delay going to the IMF to fix “deep seated” problems with the US dollar.

The 1.4 billion US dollar Chinese Yuan swap cannot be used if gross international reserves fall below 3 months of past year’s imports.

Using reserves (past savings) for imports at a given policy rate requires inflationary open market operations to offset liquidity shortages, when domestic credit demand is high, which in turn drives unsustainable imports and worsens a currency crisis.

Using central bank swaps for imports, leads to the central bank getting into external debt to effectively re-finance unsustainable domestic credit.

The rule by PBoC, which blocked the use of its swap after reserves fell below 3 months, stopped the central bank getting further into debt.

When forex shortages emerge from inflationary open market operations (liquidity injections made to keep an artificially low policy rate for flexible inflation targeting or output gap targeting) the credit system runs into forex shortages that loses the ability to exchange and settle foreign transactions and maturing debt with rupee cash inflows at the previous exchange rate.

The island then tends to borrow heavily abroad, a phenomenon officials call ‘bridging finance’.

-economynext.com