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Monday December 4th, 2023

IMF warns Sri Lanka on slowing reserve collections, money printing

ECONOMYNEXT – The International Monetary Fund has warned Sri Lanka that foreign reserve collections have started to slow and renewed a warning on money printing, amid other warnings on liberal reverse repo injections.

“Reserve accumulation has slowed in recent months,” IMF senior mission chief Peter Breuer told reporters after the conclusion of a mission to the island.

“Against continued uncertainty, it also remains important to rebuild external buffers through strong reserves accumulation.

“Building on the Central Bank of Sri Lanka’s success in controlling inflation, refraining from monetary financing will help keep inflation in check.”

Sri Lanka started to print money (on a gross basis) injecting artificial rupee reserves into banks to tempt them to overtrade (buy Treasury bills or give private credit with central bank re-finance and not real deposits) from May 2023, critics say.

Some of the money went to purchase oversold Treasury bills from the central bank’s stocks, reducing the injections on a net basis, though altering rupee reserve balances of individual banks and primary dealers.

From June, a few weeks after reverse repo injections resumed, purchases of foreign exchange from commercial banks were slightly negative while the exchange rate volatility worsened and appreciation stopped, denting confidence.

The central bank later cut the reserve ratio also dumping more liquidity into the banking system, which were for the most part also mopped up through sales of central bank held security sales.


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Analysts had warned that Sri Lanka’s central bank tends to cut rates in the second year of an International Monetary Fund program on the basis of a monetary policy consultation clause, and if the rate cuts are enforced with reverse repo injections, miss reserve targets and trigger a depreciation of the currency.

A waiver on the NIR performance criteria is then requested on the next review (Sri Lanka misses two June IMF targets: talks to continue).

In recent IMF programs, money can be freely printed to cut rates until inflation picks up again, and errors in mis-targeting rates are compensated by depreciation, which classical economists called loweringof the “value of the circulating medium”.

The falling currency and the rise in the price of energy and food prices then discredits reforms, and incumbent governments are ousted along with the IMF program.

The injections to cut rates are then blamed on the ‘budget deficit’ or ‘monetary financing’ of the deficit, because open market operations are done with securities bought back from banks, in a phenomenon classical economists called the ‘financing of merchants,’ not the government.

However due to the use of government securities for open market operations and not banker’s acceptances (accepted bills of exchange) as in classical days people are misled by interventionist inflationists that a financing of the state is taking place.

Analysts have also warned that domestic interest rates are driven by a foreign reserve target, which is essentially the financing of budget deficits of reserve currency countries, and cuts in the domestic deficit does not automatically permit interest rates to fall to very low levels quickly.

As a result the monetary policy consultation clause (inflation target) is at fundamental conflict with the fx reserve target, analysts have warned.

READ MORE Sri Lanka interest rates are dictated by the IMF reserve target, not inflation

In this program, unlike in the failed last one, there is a ceiling on the domestic asset stock of the central bank, placing somewhat of a check on its issue department (domestic operations).

Analysts have urged the central bank to sell only a little more than maturing bills in its portfolio so as not to tempt banks and primary dealers to get addicted to standing facilities, overnight or term reverse repo injections which will trigger forex shortages, especially after private credit picks up.

Regardless of whether foreign reserves are useful or not (floating regime do not have foreign reserves and in hard pegs rates move up when a small amount of reserves are used) and may encourage reserves to be run down to artificially suppress rates in the future if there is a fixed policy rate, net reserves of Sri Lanka’s central bank are now negative, which requires reserves at least to be brought to zero, analysts say.

In a new Sri Lanka monetary law, money can also be printed to target real GDP (potential output), a practice which was not permitted under the earlier law but was done anyway to try and get a growth short cut, but instead blew the balance of payments apart and triggered output shocks.

The IMF in the first few decades of its operation did not support depreciation and was set up to avoid the currency collapses that took place in the 1930s after fixed policy rates spread and came into conflict with specie anchors, analysts say.

Western central banks started to run BOP deficits in the inter-war years but worsened especially in English-speaking countries in the 1960s where unusual monetary doctrines based on econometrics which defied laws of nature emerged, leading to the eventual collapse of the Bretton Woods soft-peg system and and Great Inflation of ‘independent’ central banks of the 1970s.

When monetary stability was maintained, BOP deficits were absent and note-isssue banks were accountable to both to a specie anchor (at zero) they were also checked by classical economists who had a clear understanding of operational frameworks and an intellectual clarity about banking and external trade.

“If …a bank were established, such as the Bank of England, with the power of issuing its notes for a circulating medium; after a large amount had been issued either by way of loan to merchants, or by advances to government, thereby adding considerably to the sum of the currency, the same effect would follow…,” explained David Ricardo in High Price of Bullion.

“The circulating medium would be lowered in value, and goods would experience a proportionate rise.

“The equilibrium between that and other nations would only be restored by the exportation of part of the coin (reserve losses in modern day parlance).”

If rupees were injected after defending the currency, to enforce a fixed policy rate or prevent a contraction in reserve money, more reserves would be lost.

It is not the defending of the currency that leads to continuous reserve losses but the injection of money after reserve sales to defend a fixed policy rate resist the contraction of reserve money, (sterilization of the sale) that blows the balance of payments apart.

Ricardo explained the problem as follows:

“…[I]f the Bank assuming, that because a given quantity of circulating medium had been necessary last year, therefore the same quantity must be necessary this, or for any other reason [to defend the average weighted call money rate for example], continued to re-issue the returned notes, the stimulus which a redundant currency first gave to the exportation of the coin would be again renewed with similar effects;
gold would be again demanded, the exchange would become unfavourable…”

The law of nature is sometimes expressed in more modern times as the ‘impossible trinity of monetary policy objectives’.

In order to collect reserves, a central bank has to run deflationary open market operations (collect rupee deposits from the domestic economy). (Colombo/Oct02/2023)

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Sri Lanka stocks close up as some investor interest returns

ECONOMYNEXT – The Colombo Stock Exchange closed up on Monday, CSE data showed.

The All Share Price Index was up 0.22 percent, or 23.33 points, at 10,743.59.

The S&P SL20 index was up 0.68 percent, or 20.60 points, at 3,067.73.

Turnover was at 708 million. The banks sector contributed 189 million, while the food, beverage and tobacco sector contributed 176 million of this.

Sri Lanka’s stock market has seen some investor interest return after last week’s news that the country had managed an agreement on a debt restructuring deal with an official creditor committee, and foreign funds for some development projects resumed.

Top positive contributors to the ASPI in the day were Sampath Bank Plc (up at 71.50), LOLC Holdings Plc (up at 379.00), and Commercial Bank of Ceylon Plc, (up at 90.90).

There was a net foreign outflow of 52 million.

Citrus Leisure Plc, which announced that its banquet hall and revolving restaurant at the Lotus Tower would launch on or around Dec 9, saw its share price rise to 6.20 rupees. (Colombo/Dec4/2023).

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Sri Lanka rupee closes broadly steady at 328.10/30 to the US dollar

ECONOMYNEXT – Sri Lanka’s rupee closed at 328.10/30 to the US dollar on Monday, from 328.00/10 on Friday, dealers said.

Bond yields were stable.

A bond maturing on 01.06.2025 closed at 13.70/14.00 percent from 13.70/95 percent.

A bond maturing on 01.08.2026 closed at 13.90/14.10 percent from 13.90/14.05 percent.

A bond maturing on 15.01.2027 closed at 14.00/14.10 percent from 14.05/10 percent.

A bond maturing on 01.07.2028 closed at 14.20/35 percent from 14.15/25 percent.

A bond maturing on 15.05.2030 closed at 14.25/45 percent, from 14.20/45 percent.

A bond maturing on 01.07.2032 closed at 14.05/40 percent, from 14.00/45 percent. (Colombo/Dec4/2023)

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Gov minister highlights abortion rights, sex-ed for children, and Sri Lanka men killing their women

ECONOMYNEXT – Sri Lanka’s legislators have politicized the topics of rape and violence without addressing the elephant in the room, Jeevan Thondaman, Minister of Water Supply and Estate Infrastructure Development said in parliament on Monday (4).

“All the members here are talking about rape. What happens after that? We must talk about abortion rights. That is not something anyone wants to touch on, and that is why we are in this place right now,” Thondaman said.

“Despite alarming statistics on rape and violence, women are often blamed and punished for it. The criminalisation of abortion is a major example of this.”

Sri Lanka has some of the most restrictive abortion laws in the world. According to a 2016 estimate by the Health Ministry, he said, approximately 658 abortions take place a day, and close to 250,000 a year.

“That’s 250,000 women whose lives you are endangering.”

He added that what was needed at this point in time was comprehensive sexual education (CSE) for children and young people.

“Only through CSE in schools will children and young people develop, accurate, age appropriate knowledge attitude and skills; positive values such as respect for human rights, gender equality, diversity and attitude and skills that contribute to a safe, healthy and positive relationship.”

Thondaman pointed out that CSE plays a pivotal role in preparing young people for a world where HIV, AIDS, sexually transmitted infections, unintended pregnancies, and sexual and gender based violence still pose a risk to their well-being.

“CSE basically empowers children take control and make informed decisions freely and responsibly.”

Thondaman also highlighted the findings of a 2021 study (Fatalities_20211109_UNFPA) by the UNFPA and the University of Kelaniya that showed that a majority of women killed in Sri Lanka were murdered by those close to them.

“62 percent of homicides of Sri Lankan women are committed by either an intimate partner, ex-partner or family member. 84 percent are killed in their own homes by someone they know.”

Police and the judiciary have failed Sri Lanka’s women, the minister pointed out.

“Only 5 percent of these cases, between 2013-2017, were ever concluded. Men claim they were provoked, or are of unsound mind or have mental illness: These have been successful defenses. And the Police often express sympathy to this narrative as opposed to the victim’s.”

“We have a history of protecting oppressors.”

It takes 7-10 years for a child rape case to conclude, he pointed out.

Establishment of child courts are needed, he said, as well as several legislative amendments. “The government is working on a new law to reform the domestic violence act, reform of marriage and divorce laws to ensure there is an easier path to divorce: no one should be forced to remain in a marriage that is either abusive or not healthy.” (Colombo/Dec4/2023)

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