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Sri Lanka Central Bank loses on forex assets in 2015

Jun 01, 2016 07:12 AM GMT+0530 | 0 Comment(s)

ECONOMYNEXT - Sri Lanka's Central Bank has lost Rs19.6 billion in 2015, taking the total up to Rs76 billion over three years, with the monetary authority also making a a Rs15.1 billion loss on foreign financial assets, accounts show.

Net losses reduced from Rs32.3 billion to Rs19.6 billion.

In general a central bank makes profits from inflation, by either printing money to finance the government (profits from local currency assets) and then from currency depreciation, as printed money generates a balance of payments crisis and the domestic currency collapses.

Harmless profits can only be made on investment income from its forex assets portfolio.

In general, when inflation is low and the currency is strong, a pegged exchange rate central bank will only make moderate profits. If large volumes of liquidity is mopped up (sterilized) to build up reserves above the domestic monetary base, it can also make losses.

Sri Lanka's Central Bank has been making continuous losses for the past three years, which now total Rs76 billion. Total comprehensive losses under International Financial Reporting Standards are even higher.

In 2016, it made losses despite the currency collapsing, and a steep rise in inflationary financing of the government deficit and the winding down of mopped up liquidity.

Forex losses

According to published accounts, there was a loss of Rs15.1 billion on foreign currency financial assets, down from a Rs26.8 billion profit in 2014.

The Central Bank's gross foreign currency assets fell from $1,054 million in 2014 to Rs1,028 billion in 2015.

Meanwhile, foreign currency liabilities climbed from Rs468 billion to Rs574 billion.

"..[O]ne can argue that since a central bank can depreciate, inflate and print unlimited amounts of money, it can impoverish every saver, every wage earner and destroy the real value of every pension fund and remain solvent," the EN policy columnist warned in 2015, while accurately forecasting the build-up of the current balance of payments crisis.

"The government also remains solvent by destroying the real value of domestic currency debt and making pensioners destitute."

"This is what Sri Lanka was doing for many years. That is why Sri Lankans became poorer than say Maldivians or Singaporeans after independence. The root cause was the Central Bank, which allowed the state to spend and default repeatedly in real terms."

Changing balance sheet

The nature of the central bank's balance sheet was now changing compared to the 1980s and 1990s.

Since the 2009 balance of payments crisis, it has been accumulating debt in the form of swaps (forex guarantees given to domestic players) in a quasi-fiscal activity, which should be discouraged, and it has also borrowed from the Reserve Bank of India.

When forex liabilities mount, it can no longer inflate its way out of the problem. A similar problem was faced by the Philippines' central bank.

"In 1984, the Philippines' central bank lost 27 billion pesos, with 14 billion pesos lost on swaps and 5.3 billion pesos on forward cover," Bellwether pointed out.

"What this meant was that, when the Peso depreciated, it no longer made profits because it lost on the swap."

"This is the danger to the central bank. While it can always get out of local currency obligations by printing away and imposing losses on the general population, it cannot do the same thing for dollar obligations. Sri Lanka's reserves are not negative yet."

"But if $1.5 billion are borrowed and spent on currency defence or repayments of foreign loans, then it can get partway there."

In the past, Sri Lanka only borrowed from the International Monetary Fund. The IMF typically lends money after a float of the currency, and even then only a portion of the loan.

Bellwether also pointed out that the practice of giving 'provisional advances' also forces Sri Lanka's Central Bank to make a loss.

Depleting capital

Bellwether has advocated Central Bank reforms to stop provisional advances. The columnist also called upon the Central Bank not to transfer profits to the government.

This year, due to losses made according to the monetary law act, where it is forced to take into account unrealized losses, the profit transfer had not happened. However, provisional advances continue to be made.

W A Wijewardene, a former Deputy Governor of the Central Bank, has already warned about the depleting capital of the Central Bank.

Total equity measured in rupees has fallen to Rs54 billion in 2015 from Rs187 billion in 2012, when the Central Bank last made profits.

The depleting capital is also a reflection of the overall problem facing the Central Bank's balance sheet.

The Central Bank's net forex reserves are also no longer sufficient to cover the domestic rupee monetary base.

Bellwether says Sri Lanka is a country that is overwhelmingly driven by Mercantilist doctrine, going back to policies advocated by John Law and James Stuart.

As a result, inflation and currency depreciation in general, and Central Bank operations in particularly are poorly understood. (Colombo/June01/2016)


 

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