Mumbai: The global economy is likely to face more financial pains as the dollar swap cost has spiked to historic levels, reflecting the increased need for currency hedging by governments, corporates and investors outside the US, warns a paper by the Bank for International Settlements (BIS).

In the wake of the coronavirus pandemic, which has brought the world to a standstill, the dollar premium has started shooting over the roof, forcing the US Federal Reserve to open forex swap lines with at least five central banks on March 15.

Governments across the world are looking to raise funds in efforts to fight against the pandemic, that has killed more than 1 lakh people besides infecting millions in different parts of the world.

The paper by the Switzerland-headquartered BIS, often described as the central bank for central banks, noted that dollar funding cost in foreign exchange markets has risen sharply, reflecting demand and supply factors following the pandemic and the currency hedging needs of corporates and portfolio investors outside the US.

Over the Counter (OTC) derivatives data available with the BIS shows that outstanding global debt at the end of June 2019 stood close to USD 86 trillion, with forex swaps accounting for an estimated three-quarters of the total amount. Not surprisingly, the dollar is almost always one of the two currencies exchanged (89 per cent) and three-quarters of it are under-one-year maturity.

Nearly 89 per cent of the USD 86-trillion global debt pile is denominated in the greenback, which means any increase in the dollar swap premium will have an equal amount of additional interest burden on governments, corporations and other borrowers, as per the paper.

There can be more financial pains for the global economy as the dollar swap premium spikes, heavily burdening those nations beyond the US Fed Reserve's dollar-swap lines, it said.

The US Federal Reserve opened forex swap lines with the European Central Bank, Bank of Japan, Bank of England, Swiss National Bank and the Bank of Canada on March 15, bringing down the massive premium to some extent.

Still, broader policy challenges remain to ensure that dollar funding markets remain resilient and that central bank liquidity is channelled beyond the banking system. "Since the onset of the pandemic, dollar funding cost in forex markets have risen sharply, approaching levels last seen during the 2008 crisis.

(To download our E-paper please click here. The publishers permit sharing of the paper's PDF on WhatsApp and other social media platforms.)

Free Press Journal