By Hema Senanayake – 

Hema Senanayake

In early 1950s Sri Lanka was administered under a UNP government. In December of 1952, Sri Lanka and China signed the “Rubber-Rice Pact.” Anybody can easily understand the mechanics of the Pact; Sri Lanka exports Rubber to China and Imports Rice, it is simple and clear.

Sri Lanka is now ruled by the UPFA government. On 16th of September, 2014, i.e. a few days ago, Sri Lanka signed another landmark agreement with China; it is a Currency Swap Agreement. What is this? Unlike the Rubber-Rice Pact, most of us do not understand what this agreement is about. I wanted to write and explain the mechanics of the currency swap and its effects on Sri Lanka, so I tried to find out the specific terms of the agreement. I failed, because in the official website of the Central Bank of Sri Lanka, I did not find any information about it. Then I searched the website of the Chinese Central Bank which is known as People’s Bank of China (PBC). In PBC website, I found only the following:

“PBC Signed Local Currency Swap Agreement with Central Bank of Sri Lanka. With the approval of the State Council, the People’s Bank of China signed, on September 16, 2014, an agreement on bilateral local currency swap with the Central Bank of Sri Lanka. The size of the swap facility is 10 billion yuan/LKR 225 billion. The term of the agreement is three years and can be extended with mutual consent. The signing of the local currency swap agreement will help promote bilateral trade and investment and strengthen financial cooperation between the two central banks.” (LKR means Sri Lanka Rupee, yuan is Chinese National Currency i.e. CNY)

Since the terms of the agreement are not known to me, I will be able to explain the most general effects of the agreement. Firstly, I like this agreement, it is a historical need of China and the world trade and Sri Lanka cannot avoid it but must be careful.

We need money or currency in order to effect the settlement of payments. When we do trade with India we need usually U.S. dollars. For example, when a Sri Lankan entrepreneur wants to import something from India he or she has to open a L.C. (Letter of Credit). Basically L.C. is a letter issued by a bank to another bank in a different country to serve as a guarantee for payments after the shipment is done by the exporter. In this document, it is mentioned the name of the currency that the payment is settled by and between the two banks in the importing and exporting country; usually that currency is U.S. dollar.

There is no way that Sri Lankan importer can pay for the Indian exporter in Sri Lankan rupees. This was the case with China too; but it has now changed with the currency swap agreement. Sri Lankan importer can now pay to Chinese exporter with Sri Lankan rupees or in yuan; there is no need of U.S. dollars or euros. This is a significant change.

Let me give you another example. Previously a Chinese tourist who wanted to visit Sri Lanka needed to go to his or her bank and get U.S. dollars before come to Sri Lanka. Now a Chinese man can just come to Sri Lanka with yuan in his wallet and exchange them to rupees at the airport or in the city; no U.S. dollars involved in his visit.

From the above two examples you may see that there are chances to accumulate rupees in the Chinese banking system and yuans to accumulate in the Sri Lankan financial system. But the agreement has set a limit for such accumulations. This limit is described by the size of the swap facility. The size of the swap facility is 10 billion yuan/LKR 225 billion. What does this mean? This means at the end of the three years of the agreement, if PBC has accumulated LKR 225 billion the PBC can ask 10 billion yuan in exchange of LKR 225. Sri Lankan Central Bank is obligated to pay it under the agreement. If Sri Lankan Central Bank has only 2 billion yuan, Sri Lanka can’t pay the amount in yuan. Instead Sri Lanka has to pay the balance amount in a currency acceptable to PBC; that currency could possibly be U.S. dollars. This could possibly an important condition in the agreement.

However, this kind of situation will not arise if Sri Lanka could strike a reasonable trade balance with China. Also chances are there for a few renewals. When the yuan is firmly established in Sri Lankan financial system as a “reserve currency” similar to U.S. dollar, the China will stop renewing the agreement; this is unavoidable and is a natural evolution in the global financial system. Chinese yuan should evolve to be a reserve currency. In this regard I wrote an article to Asian Tribune in 2011 under the heading, “The US to confront China for undervaluing its currency.”

In the article I wrote:

“If Chinese political leadership is ready, the most important conditions are now ready to lay the foundation for Yuan to be an effective reserve currency before the end of the current global economic and financial crisis. Let us take a quick assessment about the most important conditions that are required to launch a reserve currency. Those conditions are:

1) the size of the physical productive power

2) monetary mass

3) delivery mechanism of the currency

4) community of nations that are willing to use (or borrow on) the new currency.

Except for the above condition (3) which is mostly technical, Chinese yuan has all the conditions in its favor.” (Asian Tribune, 2011- 10-12)

This is exactly what China is doing with currency swap agreements. They have signed currency swap agreements with many countries including some countries in Europe. This is also a justifiable strategy to avoid U.S. pressure to appreciate yuan against dollar.

However, currency swap agreement demands one important thing on our part that is to stabilize the rupee in its present value. If rupee is depreciated suddenly as was happened in 2011 this kind of agreement is not possible. Therefore, in the coming few years we will see a more stabilized rupee. The Central Bank of Sri Lanka might be extra cautious to maintain the value of rupee. Perhaps this becomes a little bit easy with the reduced importer demand on dollar with the implementation of this agreement. In addition there are chances to mount pressure to appreciate the rupee. Also appreciation of rupee is not beneficial with regard to this agreement. Perhaps there can be terms and conditions in this swap agreement about the remedial measures when a respective currency appreciate or depreciate significantly.

In brief, in the coming few years we will see a more stabilized rupee, more private trade with China, more Chinese investments in Sri Lanka, increase of Chinese tourists etc. This currency swap agreement is progressive if China limits it to the said objectives which are to promote bilateral trade and investment and strengthen financial cooperation between the two central banks. The same agreement can be used to enslave a developing nation like us in order to achieve geo-political objectives if China wants to. I hope China does not want it.