Time for Central Bank to Shift Towards FX Swaps: A Strategic Liquidity Solution Amid Growing Foreign Currency Inflows

 

Bangladesh’s foreign exchange market is currently enjoying a positive trend marked by a steady influx of foreign currency. Remittance inflows have rebounded, export receipts are on the rise, and prudent import regulation has helped maintain a healthy balance between inflow and outflow. In this context, the central bank’s continued reliance on outright purchases and sales of foreign exchange with authorized dealer (AD) banks may no longer be the most effective policy tool. A strategic shift toward introducing foreign exchange swap arrangements is now not only timely, but essential.

The central bank has long operated by intervening in the spot market-selling US dollars to inject liquidity when there is a shortage, or buying dollars outright when there is a surplus. While this method offers immediate results, it lacks long-term efficiency. Outright transactions permanently affect the central bank’s reserve position, can distort market pricing, and may send conflicting signals to market participants. As the financial system evolves and liquidity management becomes more complex, the need for a more flexible and market-oriented instrument has become evident.

FX swaps offer an alternative. A foreign exchange swap is a contract between two parties to exchange currencies at a set rate on one date, with an agreement to reverse the transaction at a future date. For central banks, this tool is invaluable in managing temporary mismatches in domestic and foreign currency liquidity, without impacting foreign exchange reserves on a net basis.

The present market conditions in Bangladesh make a strong case for the adoption of such an instrument. With rising reserves and improved inflow of foreign currency, banks are reported to hold significant surpluses in their foreign currency accounts. However, Taka liquidity remains constrained due to tightening in domestic monetary policy and higher short-term interest rates. This asymmetry is creating inefficiencies in liquidity allocation and increasing dependence on the central bank for repeated support through conventional refinance windows.

A well-structured FX swap mechanism can address this challenge. By entering into swap deals with the central bank, banks could convert their foreign currency surpluses into Taka liquidity for a short, defined period. This would allow them to continue supporting credit and trade operations without prematurely liquidating their FX holdings or resorting to informal market options. The central bank, in turn, would not need to conduct outright purchases that permanently increase reserve liabilities or inject excess Taka liquidity that could complicate monetary control.

FX swaps also help promote exchange rate stability through market-based signals. When swap operations are priced using forward premiums that reflect market expectations, they provide an indicator of future exchange rate trends. As this forward curve develops, importers, exporters, and investors gain valuable insights into currency dynamics, reducing speculation and panic-driven transactions. The spot exchange rate, in effect, begins to adjust in a self-correcting or 'autopilot' fashion, reducing the central bank’s need for daily intervention.

In fact, swaps can be a powerful tool in moving toward a more flexible exchange rate regime, without losing sight of overall stability. Rather than dictating rates or engaging in continuous firefighting, the central bank can guide the market through structured instruments that enhance liquidity and transparency. As Bangladesh Bank gradually relaxes controls in line with global integration and financial liberalization, FX swaps can play a bridging role—balancing the goals of flexibility and control.

Another key benefit is the protection of reserves. With FX swaps, the central bank does not have to permanently part with its foreign exchange assets. The temporary nature of the transaction ensures that reserves remain intact, supporting both internal confidence and external credit ratings. This feature is especially valuable in times of uncertainty, when maintaining adequate reserves becomes a strategic imperative.

The proposed swap structure would be straightforward. The central bank could initially offer short-term swaps—7, 14, 30, or 90 days—to eligible AD banks with sufficient foreign currency balances. Pricing would be based on market forward rates plus a spread reflecting the central bank’s policy stance. As the market matures, swap volumes and tenors could be adjusted to meet broader liquidity and exchange rate objectives.

Of course, safeguards are essential. Exposure limits should be imposed to avoid over-reliance by any single bank. Banks should only be allowed to use swaps for liquidity management-not speculation or arbitrage. The central bank must also strengthen its capacity to monitor swap transactions, assess risk, and enforce compliance through reporting and audit trails. The success of the swap framework will depend not just on its design, but on its disciplined execution.

Globally, the use of FX swaps by central banks is well-established. The central banks of India, Malaysia, and Indonesia all deploy swaps routinely as part of their liquidity management toolkit. These countries have demonstrated that swaps can support not only monetary policy, but also macroprudential stability and financial sector development. Bangladesh has reached a point in its financial maturity where adopting such a tool is both feasible and necessary.

FX swaps could also serve as a stepping stone to a deeper forward foreign exchange market in Bangladesh. Once banks become accustomed to using forward premiums in their pricing models, it opens the door to more advanced hedging and risk management instruments. This would allow exporters and importers to lock in exchange rates for future transactions, improving predictability and reducing vulnerability to currency fluctuations. Over time, such developments would contribute to a more robust and diversified financial market.

The adoption of FX swaps is not merely a technical adjustment-it is a strategic evolution. It signals a central bank that is forward-looking, responsive to market dynamics, and committed to institutional innovation. It also signals to market participants that Bangladesh’s monetary and exchange rate policy is entering a more mature phase, one that balances flexibility with discipline.

As the economy becomes more open and the financial system more integrated with global flows, traditional tools like outright interventions and direct controls will lose their effectiveness. A modern, rules-based FX swap framework gives the central bank a powerful alternative-one that can influence liquidity, guide expectations, and reinforce confidence, all without destabilizing markets or compromising reserves.

The central bank has already taken several commendable steps in recent months to liberalize and modernize the external sector-streamlining outward remittance approvals, simplifying trade documentation, and enhancing offshore banking facilities. Introducing FX swaps would complement these efforts by aligning monetary operations with the realities of a growing and increasingly complex financial ecosystem.

The current moment presents an ideal opportunity. With foreign currency inflows strengthening and inflation expectations stabilizing, the timing is perfect for a bold but balanced policy move. Introducing FX swaps would not only provide a needed liquidity tool, but also mark a decisive shift toward market-based monetary governance.

Rather than relying indefinitely on outright purchases and sales of foreign currency—a blunt and often disruptive instrument—central bank should embrace the flexibility, transparency, and reversibility of FX swaps. It would be a win-win solution: banks gain a reliable liquidity management tool, and the central bank retains strategic control while preserving reserves. It would also reduce dependency on informal markets and foster a more predictable exchange rate environment.

In short, FX swaps offer a pathway toward smarter, more adaptive central banking. The time to act is now. Bangladesh should not miss the opportunity to modernize its policy framework in a way that supports both present stability and future resilience. 


Mehdi Rahman works in the development sector. He also 
writes on business phenomena 
and monetary issues.