China approves $1.5 billion currency swap with Sri Lanka

China Sri Lanka flags

China has approved a 10 billion yuan ($1.54 billion) currency swap with Sri Lanka, a government spokesman in Colombo said on Wednesday, giving some respite from concerns about public finances.

The deal will allow the island to weather “present difficulties”, State Minister of Money & Capital Market and State Enterprise Reforms Ajith Nivard Cabraal said in an interview with the Daily Mirror earlier on Wednesday.

Sri Lanka’s government bonds surged after the announcement, with Sri Lanka’s dollar-denominated bond due in July 2021 climbing 3.5 cents to 96.3 cents and its highest level since March 2020. The January 2022 issue jumped 4.8 cents, Tradeweb data showed.

Dwindling foreign reserves, a tumbling currency and rising debt levels have dogged Sri Lanka over the last year, leading to increasing fears of a default.

The government of Prime Minister Gotabaya Rajapaksa – which has drawn the country closer to China to the frustration of neighbour India – says this will not happen. It has called downgrades by credit rating agencies and negative comments from investment banks in recent months politically motivated.

“(The swap deal) buys time given FX reserves are at multi-year lows and there are still significant FX payments into year end,” said Raza Agha, head of emerging markets credit strategy at Legal & General Investment Management.

“But the question remains – buy time for what? The need of the hour is an IMF program to anchor fiscal consolidation given government debt was projected at just shy 100% of GDP at the end of last year,” said Agha.

Sri Lanka had previously sought a fresh currency swap deal with India.

But that prospect diminished after India said any further extension of existing funding was contingent on Sri Lanka having a staff-level agreement for an IMF program, Patrick Curran, senior economist at Tellimer, wrote in a recent report, noting the government’s position of “continuing to resist an IMF program.”

Sri Lanka’s central bank governor W.D. Lakshman said last month the country was in talks with foreign governments and multilateral partners regarding financing options.

($1 = 6.5108 Chinese yuan renminbi)