ECONOMYNEXT - Sri Lanka's forex reserves rose $124.5 million to $6.613 billion in August 2016 from a month earlier, in a month that the Central Bank bought and swapped dollars and allowed liquidity to fill cash shortages.
The Central Bank bought $190 million from commercial banks in the month and sold $57 million. It also engaged in more swaps including with a state bank, acquiring more dollars.
The Central Bank's key domestic asset portfolio, Treasury bills fell from Rs273 billion to Rs212 billion in August, indicating that the monetary authority had bought or swapped around $400 million during the month and allowed a liquidity shortage to be filled with rupee proceeds.
The liquidity shortage came from July, when the Central Bank defended the rupee amid strong credit growth and injected liquidity overnight, giving more rupee reserves for banks to lend and generate imports.
The swapped dollars came to a state bank after the Treasury repaid a tranche of maturing Sri Lanka Development Bonds with proceeds of a sovereign bond.
The dollars shifted from the fiscal reserve to the monetary reserve. Official reserves are those held by both the Central Bank and the Treasury.
The Treasury, however, can borrow or sell dollars without affecting the domestic monetary base (a monetary policy neutral transaction). Any Treasury dollar sales strengthens the rupee.
However, dollar sales by the Central Bank will contract the monetary base, reducing liquidity (an unsterilised sale) and influencing interests to go up.
A soft-pegged Central Bank will then typically sterilise the dollar sale by printing money to fill the liquidity shortage and keep rates down, precipitating a balance of payment crisis.
Sri Lanka, Mexico, Venezuela, Russia and Argentina regularly engage in such practices for sustained periods, creating monetary instability and ultimately destroying their currencies in an economic crisis and high inflation.
The Sri Lankan rupee collapsed from Rs131 to Rs147 during the current 'Yahapalanaya' balance of payments crisis. (Colombo/Sept11/2016)