IMF asks Sri Lanka’s central bank to wind down forex swaps

ECONOMYNEXT – Sri Lanka’s central bank has been asked to slash a portfolio of about 2.0 billion US dollars of swaps, by the International Monetary Fund and any new dollars acquired through derivatives will no longer be counted for a forex reserve targets under a deal with the agency.

The central bank will instead have to buy dollars outright.

"The most stable way for the central bank to acquire foreign exchange is through outright cash purchases," IMF mission chief Jaewoo Lee said.

Reserves acquired through swaps depended on the willingness of the counterparty to roll them over, Lee said.

A swap is an obligation which the central bank has to make good when the swap matures and is therefore encumbered and may not be available for its use when most needed.

By end December 2015 the central bank had 2,135 million US dollars of swaps outstanding.

Under the program the central bank has to wind down outstanding swaps to 20 percent of gross international reserves.

The central bank also engaged in swaps to meet a net international reserve target this year. Under a revised deal for the rest of the program period, dollar acquired from swaps will no longer be counted.

Long time central bank watchers have been warning for several years that the swaps – which effectively transfers forex risk from commercial banks to the central bank – are an un-necessary risk and it also amounts to a quasi – fiscal activity better undertaken by the Treasury.

Some of the swaps have been given at below market rates.

While in theory the central bank can make profits from swaps, Sri Lanka’s soft-pegged central bank which prints money extensively from time to time to generate balance of payments trouble, and then sharply depreciates the currency.

Such actions can impose large losses on the central bank. The central bank of Philippines which was set up along a similar monetary law to Sri Lanka went bankrupt, partly due to swaps given to domestic market participants.

Economists and analysts have called for the central bank to be abolished and a Hong Kong or Singapore style currency board to be re-stablished to end currency collapses and BOP troubles and prevent the impoverishment of ordinary people.  (Colombo/Dec10/2016)