CBSL makes RMB 10 billion drawdown under currency swap agreement with PBOC in 2021

On September 16, 2014, the Central Bank of Sri Lanka (CBSL) and the People’s Bank of China (PBOC) signed an RMB 10 billion (LKR 225 billion/$1.5 billion), bilateral currency swap agreement to facilitate trade and improve foreign currency liquidity in Sri Lanka. The agreement had a three-year term but was not renewed in 2017. Then, on March 19, 2021, the CBSL and the PBOC signed another RMB 10 billion (LKR 225 billion), bilateral currency swap agreement (with a three-year term) to facilitate trade and improve foreign currency liquidity in Sri Lanka. In November 2021, the CBSL announced that it had decided to draw down on the RMB 10 billion currency swap facility with the PBOC. Then, on December 29, 2021, the currency swap arrangement was ‘activated’ through an agreement signed by the CBSL and the PBOC. The agreement reportedly specified that ‘[t]he amount received under this agreement can be used to finance trade and direct investment between the two countries and for other purposes agreed upon by both parties.’ Multiple sources indicate that the entire RMB 10 billion currency swap facility was utilized (drawn down) by the CBSL between December 29, 2021 and December 31, 2021. CBSL’s 2021 Annual Report identifies the amount outstanding under its PBOC currency swap facility as RMB 10 billion as of December 31, 2021. The December 2021 (gross) drawdown had an initial maturity of 1-year but the CBSL had the option of initially rolling over its debt (i.e. extending the final maturity date) in December 2022. According to a confidential source within the CBSL, its PBOC swap debt can be rolled-over multiple times within its 3-year validity period (March 19, 2021 to March 18, 2024), with the consent of both parties, and no interest is charged because the PBOC swap agreement is considered to be a ‘standby agreement’. The parties to the swap agreement also adopted a mechanism to compensate for exchange rate fluctuations, according to a confidential source within the CBSL: if a swapped currency depreciates by more than 5% against the other currency, the respective accounts of the central banks are to be replenished accordingly. At the time that the CBSL activated the currency swap agreement with PBOC, the Government of Sri Lanka’s foreign exchange reserves were low and it was anticipating the need to repay $4.5 billion in debt in 2022 (starting with a $500 million international sovereign bond maturing on January 18, 2022). However, questions arose in June 2022 about whether the PBOC swap proceeds were in fact useable source of foreign currency. The currency swap agreement between the CBSL and the PBOC reportedly specifies that use of any drawdown amounts (foreign currency deposits) requires that Sri Lanka’s gross official foreign exchange reserves are greater or equal to the average value of 3-months’ worth of merchandise imports (approximately $4 billion). However, between May 2021 and December 2022, Sri Lanka’s gross official foreign exchange reserves were less than $4 billion. In the last quarter of 2022, CBSL published multiple reports that acknowledged that its swap agreement with the PBOC was subject to ‘conditionalities on usability’.

Additional details

1. A bilateral currency swap (BCS) agreement — also known as a central bank liquidity swap agreement — is an agreement between the central banks of two countries to exchange cash flows in different currencies at predetermined rates over a specified period of time. Central banks participate in these agreements to facilitate bilateral trade settlements using their national currencies (rather than relying upon on a third-party currency such as the U.S. dollar), manage demands from their local banks, and provide liquidity support to financial markets. The party that draws down on the swap line becomes the borrower and the other party becomes lender. During the term of the swap, the party that draws down on the swap line makes either fixed or floating interest payments on the principal amount. If both parties draw down on the swap line, then both parties exchange fixed or floating interest payments on the principal amounts. The 5-step process of drawing upon a currency swap line with the People’s Bank of China (PBOC) can described from the perspective of an importer in a given country (‘Country X’) seeking to settle trade with a Chinese firm in RMB. Step 1: The central bank of Country X and the PBOC activate their currency swap in advance, at which point each party deposits a specific amount of its currency in an account controlled by the other party (i.e. the central bank of Country X deposits local currency in an account controlled by the PBOC, and the PBOC deposits an equivalent amount in RMB in an account controlled by the central bank of Country X). Step 2: A firm in Country X that imports goods from China applies for an RMB-denominated loan from a domestic bank. Step 3: The domestic bank in Country X that receives the loan application then applies to its central bank for an RMB-denominated loan. After a review process, the central bank of Country X notifies the domestic bank applicant that its loan application was approved. The central bank of Country X subsequently requests that the PBOC transfer RMB funds from the central bank of Country X’s swap account within the PBOC to the loan applicant’s account with a corresponding bank in China. Step 4: The domestic bank in Country X directs the corresponding bank in China to transfer RMB funds into a Chinese exporter’s account, and the corresponding bank in China provides RMB funds to the Chinese exporter. Step 5: The importer in Country X repays the RMB-denominated loan at its maturity date. The domestic bank notifies the central bank of Country X of the repayment, and transfers RMB into the central bank’s account within the PBOC through the corresponding bank in China. For the central bank of Country X, the RMB deposit is an asset that should be recorded on its balance sheet as an official reserve asset denominated in RMB. The contra entry of this asset is the liability in the local currency of Country X that represents China’s claims in the central bank of Country X. This should be also recorded on the balance sheet of the central bank of Country X. At the time of the exchange of currencies, it should be recorded as an increase in assets and an increase in liabilities of the monetary authorities in the balance of payments. The reason why the PBOC uses this mechanism to provide renminbi liquidity to other central bank is to increase the speed, convenience, and volume of transactions between the two countries. More detailed information about currency swaps with the PBOC can be found at https://www.imf.org/-/media/Files/Publications/WP/2021/English/wpiea2021210-print-pdf.ashx and https://thechinaguys.com/the-rise-of-the-renminbi-the-reality-of-bilateral-swap-agreements/ and https://www.imf.org/external/pubs/ft/bop/2017/pdf/17-25a.pdf. 2. AidData treats drawdowns under BCS agreements with the PBOC as collateralized loans because, in a BCS arrangement, the currency of the borrower is held as collateral while the lender receives interest on the amount drawn down by the borrower until repayment is made. 3. Multiple sources indicate that the entire RMB 10 billion ($1.5 billion) currency swap facility was utilized by the CBSL (see https://www.economist.com/asia/2022/01/13/sri-lanka-is-flirting-with-default and https://economynext.com/chinas-10bn-yuan-swap-with-sri-lanka-is-unique-says-envoy-89460/ and https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/Full_Text_Volume_I.pdf and https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/Full_Text_Volume_II.pdf). 4. Volume 1 of CBSL’s 2021 annual report (https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/Full_Text_Volume_I.pdf) notes that '[a]midst significant debt servicing obligations falling due during the year, the Government and the Central Bank received some inflows that enabled replenishment of the GOR to a certain extent. These included the Special Drawing Rights (SDR) allocation by the IMF, two foreign currency term financing facilities from the China Development Bank, and international currency swap agreements with the People’s Bank of China (PBOC) and the Bangladesh Bank.” And “the Central Bank’s currency and deposits liability position increased by end 2021, as a combined effect of entering into new bilateral currency swap arrangements with PBOC amounting to CNY 10 billion (equivalent to around US dollars 1.5 billion) and the Bangladesh Bank (US dollars 200 million) and the settlement of the SAARCFINANCE swap facility with the RBI (US dollars 400 million) during the year.' Volume 2 of CBSL's 2021 annual report (see https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/Full_Text_Volume_II.pdf ) notes that '[t]he cash balance available for restricted use represents the CNY 10 billion received under the bilateral currency swap agreement between CBSL and the PBoC as explained in Note 25.6' and '[u]nder this agreement, in December 2021, CNY 10 billion (equivalent to USD 1.5 billion) was received from the PBoC, which can be utilized for restricted use (Note 8.1) in exchange of an equivalent amount of LKR for a period of one year. Outstanding balance as of 31 December 2021 represents CNY 10 billion swap in December 2021 for a period of one year, and the first roll-over is due in December 2022, subject to the mutual consent of the PBoC and the CBSL.' 5. Multiple CBSL press releases suggest that CBSL was hoping to use the PBOC swap drawdown (and the receipt of a CDB balance of payments loan) to influence the credit rating agencies. See https://www.cbsl.gov.lk/en/news/government-strongly-disputes-hurried-rating-action-by-fitch-ratings and https://www.cbsl.gov.lk/en/news/ill-timed-and-unacceptable-rating-action-by-moody-s-renews-concerns-of-subjectivity 6. The PBOC swap agreement specifies that '[t]he amount received under this agreement can be used to finance trade and direct investment between the two countries and for other purposes agreed upon by both parties.' See https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/Full_Text_Volume_II.pdf and https://www.cbsl.gov.lk/en/node/9944 and https://www.dropbox.com/s/we3udfa91iamdih/%241.5%20bn%20Chinese%20swap%20came%20with%20impractical%20conditions%20-%20The%20Morning%20-%20Sri%20Lanka%20News.pdf?dl=0 7. Most central banks publish their end-of-year outstanding PBOC swap debt, but only a few report detailed transaction-level data on drawdowns during the year. Therefore, if no information on drawings is available, AidData assumes that total drawdowns during the reporting period equal the amount outstanding at the end of the reporting period (and vice versa). Since the (de jure) maturities of PBOC swap drawings are 12 months or less, this creates a lower bound estimate for actual drawdowns under the PBOC swap line. 8. PBOC swap debt is frequently rolled over. In central bank reports where one can only observe the year-end outstanding amount, no distinction between rollovers and drawdowns is possible. In these cases, one can derive (new) drawdowns as the difference between the current and last year’s outstanding swap debt stock. This measure essentially captures net lending through the PBOC swap line.

Number of official sources

19

Number of total sources

38