Foreigners get 2-year hedge against forex risk on G-sec investments

„Move aimed at reducing commercial borrowing and supporting rupee „Will apply for new bond purchases between Rs.25mn and Rs.1bn

The foreigners who will invest in rupee bonds will get a forex risk cover up to two years from the Central Bank, as the government is working towards wooing dollar investments into Treasury bills and bonds, in a bid to lessen the reliance on commercial borrowings and supporting the currency.

To this effect, the Cabinet of Ministers has approved a paper put forth, proposing to provide swaps of up to two years to the foreigners who will invest in rupee bonds.

A fortnight ago, Finance State Minister Ajith Nivard Cabraal said in Parliament that the government intends to hedge the foreign exchange risk of foreigners via swaps, to provide some incentive to them to buy rupee bonds, as foreigners have continued to flee the rupee bond market since 2015.

Coinciding with the statement by Cabraal, foreigners returned to the bond market, adding Rs.1.73 billion in the two weeks ended on September 16, as they successively purchased bonds to the tune of Rs.870 million and Rs.858 million in the two weeks.

The foreigners who held Rs.453.3 billion or US $ 3.5 billion worth of government securities by January 7, 2015, slumped to Rs.11.8 billion by September 8, 2020, before gaining to Rs.13.5 billion by September 16.

However, if the trend would continue in the medium term is yet to be seen.

Nevertheless, frontier market bonds such as rupee bonds provide a higher risk premium to foreign investors chasing for higher yields, as yields at the US and European markets hover at near zero or negative levels, since their central banks cut rates to provide monetary stimulus to their economies battered by the pandemic, by bringing down the borrowing costs drastically.

The Cabinet decision will be effective for new bond purchases between Rs.25 million and Rs.1.0 billion.

Analysts say the decision to provide the forex cover is the right move in the right direction to woo back investors, as Sri Lanka has to resort to some innovative and unconventional strategies to win back investments and bring back high growth, which is sine qua non to enhance incomes and bring economic prosperity to a wider swath of people. Forex swap is a derivative used widely in cross-border transactions, to provide hedge against possible fluctuations in the exchange rate of a country against the currency of the other trading partner.

Any foreign exchange losses, which could arise due to the timing difference, will be netted off against the future profit transfers from the central bank to the national treasury.

During Cabraal’s tenure as Central Bank Governor, a similar arrangement was introduced via a swap to hedge part of the forex risk by the Central Bank, when government banks were raising dollar funds, to lend to projects and other identified sectors.