The above is news from Indian Express. Let us understand few p | ECONOMY by VIVEK SINGH

The above is news from Indian Express. Let us understand few points. Read it carefully.

1) The currency swap agreement between two countries (say A and B) happens at Central Bank Level. Country A gives its currency to country B and country B will give its own currency to country A. And the countries will keep on paying the interest on the currency which they have taken from the other country. And after a fixed period the swap is again reversed which means country A will get the principal amount from B and country B will get the principal amount of its currency from A. This is a kind of Standard agreement.

But now there can be certain deviations in such agreements depending on mutual agreement like:

(a) Country A takes the currency of B but B does not require/take the currency of A. See it will not impact BECAUSE country A will keep on paying the interest on the currency and amount which it has taken from B and after a fixed period country A will return the principal amount also to B. So, in this case B did not take anything from A BUT it does not matter because A has kept on paying interest on the money taken and then paid the principal. So, this is a kind of credit/loan facility for country A because B did not take any currency from A. That is why in this case it is called an (open ended) credit/loan facility. Why open ended because two countries can sign such agreements for a certain period but they will use only when required.

(b) This swap agreement can also be in the form of third currency. Now in the above news, Sri Lanka wants dollars but not Bangladeshi currency and Bangladesh do not require at all any Sri Lankan currency. So, in this swap agreement a third currency has been offered. So, Bangladesh will offer dollars (from its dollar reserves just for help) to Sri lanka and Sri lanka will keep on paying interest in dollars and after a fixed period Sri Lanka will return the (principal amount) dollars. So, ideally Sri Lanka should pay interest in dollars because it has taken dollar currency from Bangladesh but upon request of Sri Lanka, Bangladesh may allow Sri Lanka to pay interest in Sri Lankan currency. So there can be variations/exceptions and accordingly calculations can be done. Since Sri Lanka will keep on paying interest on the amount taken from Bangladesh and will return the principal amount (in dollars) too after the fixed period, SO it does not matter even if Bangladesh did not take any currency from Sri Lanka or not. AND if Sri Lanka is not able to pay the dollars (principal) amount they both the countries can adjust this in trade (imports from Sri Lanka into Bangladesh).

2) If Sri Lanka will borrow the same amount of dollars from the market, it will have to pay much higher interest rate. If Sri lank sells its own currency and purchase dollars in the forex market then its currency may start depreciating a lot. So, in such situations, currency swap agreements become helpful because these are OUT OF MARKET transactions at country level.

3) So, currency swap agreements are quite helpful in case a country's forex reserve is declining and it has obligations which can be settled only in dollars/forex like repayment of external loan or imports of some essential.