ECONOMYNEXT – Sri Lanka’s output gap targeting, intermediate regime central bank has posted a net loss of 374 billion rupees in 2023 and made a loss of 778 billion rupees on negative foreign reserves, official data showed.
Foreign reserves of Sri Lanka’s central bank turned negative after it borrowed and lost dollars in 2022 as liquidity was injected through inflationary open market operations to suppress rates using the cover available from data-driven flexible inflation targeting.
Forex shortages emerge quickly from inflationary open market operations but it may take up to a year or 18 months for ‘inflation’ to show up in a retail price index after private credit becomes positive from the end of the previous currency crisis.
The central bank borrowed from the Reserve Bank of India and Bangladesh through swaps.
Losses from swaps totaled 127 billion rupees in 2023.
The central bank started the 2020-22 output gap targeting exercise with an outstanding loan from the International Monetary Fund from an earlier currency crisis. There is also a liability now under the Asian Clearing Union.
The overall revaluation forex loss was 610 billion rupees in 2023 from negative reserves. Usually a pegged central bank with reserves makes profits if there are residual reserves.
Interest costs on foreign exchange liabilities were 32 billion rupees.
Sri Lanka’s dollar liabilities went up in three areas as forex shortages emerged from flexible inflation targeting/output gap targeting and the country lost the ability to settle loan installments and other payments from inflows.
As forex shortages emerged from flexible inflation targeting from 2015, Sri Lanka initially borrowed through International Sovereign Bonds and budget support loans from China to cover current spending as well as to settle maturing loan installments in the years with inflationary monetary policy.
The Ceylon Petroleum Corporation was made to borrow dollars as inflationary open market operations triggered forex losses. The CPC also suffered massive losses at each depreciation from suppressed policy rates.
As credit rating fell and the central government and CPC gradually lost the ability to borrow in each currency crisis the central bank borrowed money heavily in the last year.
The central bank’s gross borrowings which were 1.4 billion dollars in 2019 went up to 2.1 billion US dollars in 2020, 3.5 billion dollars in 2021 and 5.2 billion US dollars in 2022.
Eventually it ended up with gross reserves from a swap with China, which it was not allowed use for imports after printing money.
Related Sri Lanka central bank US$4bn in debt by March 2022
The central bank’s equity in rupees collapsed to 82 billion rupees from 463 billion rupees a year earlier from the losses.
The Central Bank of Sri Lanka made profits of 487 billion rupees on its domestic assets book where money was printed and given to holders of maturing bonds from past deficits and to offset (sterilize) forex interventions with inflationary open market operations as well as some financing of actual deficits.
In previous years transfer of reserves in rupee had led to more foreign reserve losses.
From 2015 to 2022 Sri Lanka had monetary stability to settle foreign loans, make other payments like oil and collect reserves only in 2017 and 2019.
Monetary stability has been restored at great cost in 2023 by the central bank. The currency appreciated in March. When currencies appreciate, a central bank with negative reserves will show profits on its dollar book.
Sri Lanka got caught up in the what classical economist Robert Mundel called the international disequilibrium system in August 1950. (Colombo/Apr28/2023)