ECONOMYNEXT - Sri Lanka's gross forex reserves fell to 8,769 million US dollars in May 2018 from 9,935 million US dollars in April, official data showed.
Official reserves rose sharply in April from just 7,309.11 million US dollar helped by dollars raised by the Treasury.
So-called official reserves include central bank's monetary reserves collected by sterilizing dollar purchases (curtailing domestic credit) and also inflows to the government which are kept as dollars.
Inflows to the government are used to settle foreign debt and can move down without de-stabilizing the domestic monetary system. Some of the dollars raised in April was expected to be used to settle debt.
The May foreign reserve number at 8,769 million dollar is still higher than the 7,309.11 million US dollars reported in March 2017.
The central bank bought up to 200 million US dollars a month from forex markets in the several months leading up to March 2018 as domestic credit slowed and interest rates fell.
Analysts had warned that the central bank would not be able to collect that volume of dollars, if domestic credit picked up.
In March the central bank also terminated repo deals, releasing liquidity and rates were cut in April releasing more liquidity.
When liquidity is released it is no longer possible to collect reserves, except by depreciating the rupee and inflating the base money.
However from late May the central bank has improved monetary policy, analysts say despite some foreign selling in rupee bonds.
If liquidity is not released by the central bank for banks or primary dealers to buy bonds from exiting foreign investors, banks will have to contract domestic credit (and imports) with rates moving up.
As a result the shock of capital flight is borne by imports and interest rates rather than foreign reserves.
However as the central bank has a policy ceiling at 8.50 percent it is compelled to inject liquidity to keep rates going above that. So far the central bank has injected only overnight cash, making it less easy for banks to fund credit (or bond purchases) with new money.
The central bank also sold down 15 billion rupees of its bond portfolio, generating a liquidity shortage. (Colombo/June14/2018)