ECONOMYNEXT – Net foreign assets of Sri Lanka’s commercial banks have turned positive in the first quarter of 2023 official data show, amid a domestic credit contraction as banks paid down foreign credit lines.
Measured in rupees, the combined foreign assets of domestic and offshore banking units of Sri Lanka’s commercial banks grew 61.5 billion rupees (about 170 million dollars) in February 2023 from a negative 33.1 billion rupees in January 2023.
By March 2023, net foreign assets of the banking system went up to 80.3 billion rupees (about 245 million US dollars).
By March 2023, net foreign assets were positive by 494.4 billion rupees, indicating that bank dollar deposits were invested abroad on a net basis.
Domestic banking units were still negative by 414.1 billion rupees by March, down from 446 billion rupees in February. Sri Lanka’s banks borrowed abroad to lend domestically including through Sri Lanka Development Bonds over a decade or more.
Banks found it difficult to roll-over credit lines in 2021 as Sri Lanka’s credit was downgraded amid money printing (mis-targeted rates), which led to a drain in reserves.
Paying down foreign loans of banks reduces domestic investments or consumption or both which in turn reduces imports, narrowing the external current account deficit.
Foreign direct investments foreign borrowings by the private sector or the government will expand the current account deficit.
Using central bank reserves for imports (which involve printing more money to fill liqudity shortages in banks to maintain a policy rate) also expands domestic credit and the current account deficit.
Sri Lanka’s current account deficits are mostly driven by budget deficits financed abroad, and in times of currency crises, by rundowns of official reserves.
Mercantilism taught in Anglophone universities in the last century after the fixed policy rate was devised, have linked current account behaviour to export competitiveness.
They believe current account behavior is linked to ‘real’ exchange rates and not savings-investment behaviour.
Mercantilists believe that depreciation of the currency will increase export competitiveness and not social unrest and poverty, triggering more capital imports as domestic capital is inflated away, eventually ending in sovereign default.
The mis-understanding about the balance of payments, propagated by John Maynard Keynes involves the so-called ‘transfer problem’ of the 1920s linked to Weimar Germany’s external deficits and default.
Economists including Bertil Ohlin and Jacques Rueff tried to explain the phenomenon to Keynes ( Transfer difficulties, Real or Imagined) but failed.
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Sri Lanka is now paying back private debt and is also building official foreign reserves. Building official reserves also has the same effect on the domestic economy as repaying foreign debt.
Amid the private credit contraction and better management of state energy utilities, Sri Lanka’s central bank has also allowed the exchange rate to appreciate strengthening the underlying monetary standard of the country. (Colombo/May22/2023)