Currency swap explained in simple words | Bangladesh - Sri Lanka currency swap | ECONOMICS
What is a currency swap?
A currency swap is an agreement to exchange currency between two foreign parties, in which they swap principal and interest payments on a loan made in one currency for a loan of equal value in another currency.
Assume that you are in need of 1 million USD for a period of 5 years to expand your factory which is in the USA.
Obviously, you'll plan to borrow the money from any bank in the USA.
But there exists a problem, what if the rupee value falls steeply.
If it falls, your debt burden from this loan will go up in rupee terms.
For instance, 1 million USD today is equal to Rs 7 crores (at $1 =Rs 70).
So, when the rupee value falls to Rs 100 (i.e, $1 =Rs 100), you'll have to pay Rs 10 crore at maturity.
Now you came to know that there is a USA businessman Antony, who is in need Rs 7 crore (Indian money).
This is an opportunity. If Antony agrees, you will give him your Rs 7 crore and he will give me $1 million. As both amounts are equal in value.
Here, you should give him an interest rate in dollars. Similarly, he'll give the Indian interest rate in rupees, for five years.
At the end of the 5th year, Antony will give you back Rs 7 crores and you will give him back the $1 million. Here, you have simply re-exchanged the original principal amounts.
This arrangement is called a currency swap.
A currency swap is also done by governments. (apply the same example)
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In News
Bangladesh has approved a $200 billion currency swap facility to Sri Lanka.
This will help Sri Lanka to manage its foreign exchange crisis it is currently facing.
Isn’t it unusual for Bangladesh to do this?
Bangladesh has not been viewed so far as a provider of financial assistance to other countries.
It has been among the most impoverished countries of the world, still receives billions of dollars in financial aid.
But over the last 2 decades, its economy has pulled itself up literally by the bootstraps, and in 2020, was the fastest growing in South Asia.
This may be the 1st time that Bangladesh is extending a helping hand to another country, so this is a landmark of sorts.
Why didn’t Sri Lanka approach India, the biggest economy in the region?
It did ask India, for a $1 billion credit swap last year.
But India-Sri Lanka relations are now tense over Sri Lanka's decision to cancel a valued project at Colombo Port.
Sri Lanka's economy is in a bad shape furthered by pandemic, already deep in debt to China.
