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Sri Lanka allows banks to buy cheap sovereign bonds with new dollars

ECONOMYNEXT – Sri Lanka banks would be allowed to buy sovereign bonds of the country which are trading at a steep discount provided the dollars are new inflows, the central bank said.

On March 19, the central bank banned banks from buying sovereign bonds outright for three months, after rate cuts and liquidity injections triggered forex shortages sending the rupee crashing.

On June 19, the central bank said commercial banks and National Savings Banks should not buy “Sri Lanka International Sovereign Bonds (ISBs) for a period of three months unless such purchase of ISBs is funded by using new foreign currency inflows to the banks.”

Sri Lanka’s sovereign bonds, especially one due on October 2020 has been trading at steep discounts of about 20 to 30 percent below par at times, making them attractive buys for investor who do not expect default in 2020.

Not only domestic banks but the Treasury itself would benefit from early buy backs of ISBs which would save hundreds of millions of dollars for the Treasury generating instant profits, analysts say.

Sri Lanka has suffered monetary instability shortly after the central bank was set up in 1951 with an exchange control law in 1952 which led to a full economic closure in the 1970s as the Bretton Woods system collapsed.

Relative stability was kept during the war years with tight monetary policy which was started by then Governor A S Jayewardene.

However policy started to deteriorate from late 2011, had has severely deteriorated in the past three years with call money rate targeting, critics have said.

Sri Lanka operates a soft-pegged exchange regime where a credible eternal anchor is avoided with ‘flexible’ exchange rate where the rupee is allowed to slide after printing money.

A credible domestic anchor is avoided with ‘flexible’ inflation targeting with a high enough inflation targeting and call-money-rate-targeting-with-excess-liquidity to conflict with the ‘flexible exchange rate’ and trigger external instability. (Colombo/June20/2020)

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