ECONOMYNEXT – Sri Lanka’s banks have repaid foreign debt or collected up to 1.7 billion US dollars from January to September 2023, official data show, as more market driven interest rates reduced domestic credit and investment.
Net foreign assets of Sri Lanka’s commercial banks went up to 426 billion rupees (about 1.31 billion US dollar, up from a negative 153 billion rupee (about 424 billion rupees) in December.
Bank foreign assets were negative by 732 billion rupees (about 2.1 billion US dollars) by April 2022 when rates were hiked by Governor Nandalal Weerasinghe to stop mis-targeting.
G-sec yields rose as investors bought bonds, despite the threat of a deliberate default through domestic debt restructuring, ending possible hyperinflation. Taxes were also raised later by President Ranil Wickremesinghe to reduce domestic credit and fuel market priced to reduce SOE credit.
Banks were later repaid dollar bonds in rupees, triggering an imbalance in their forex exposure (net open positions), with no dollars to balance their deposits and credit lines taken to provide the loans to the government.
Banks then bought dollars in the open market to repay maturing credit lines or simply to collect dollars to cover their foreign currency deposits which were then parked in nostro accounts of correspondent banks. Banks also had to provide for hair cuts on sovereign bonds.
Since April 2022 commercial banks have collected dollars or repaid debt amounting around 3.4 billion US dollars. The central bank has also collected reserves from around September 2022.
While the default ended most government debt repayments it triggered private outflows as credit lines were not rolled over and the ability to get new loans were lost.
Market interest rates and ending central bank inflationary policy (reverse repo injections) halts forex shortages allowing foreign loans to be repaid.
Sri Lanka’s government borrowed heavily through sovereign bonds and also Sri Lanka Development Bonds after the end of a civil war as repeated rate cuts enforced with printed money to push growth from around 2011, triggered repeated currency crises.
Printing money for growth systematized as targeting ‘potential output’ after 2015 has now been legalized in an overtly inflationist monetary law backed by the International Monetary Fund in 2023, critics have warned.
Keynesians who mis-target rates through bureaucratic policy rates believe that it requires an external current account surplus to repay debt, and are usually unable to grasp that the repayment of debt (a deficit financial account) through an unhampered market rate is what triggers a current account surplus.
The false doctrine was expressed by J M Keynes as the “transfer problem” which classical economists pointed out in the 1920s was a non-existent problem as long as there was no bureaucratic policy rate.
Any money borrowed from the domestic market – Treasuries issues in the case of the government, and deposits and loan repayments in the case of banks – automatically reduce domestic spending and investment of the private sector, reducing imports or other outflows and creating the required foreign exchange to repay debt.
“Sri Lanka’s so-called Active Liability Management Law is an overt reflection of the spurious monetary doctrine as reflected in the Keynesian transfer problem”,” says EN’s economic columnist Bellwether.
Analysts had warned several that the mis-understanding over the balance of payments and the transfer problem would lead to sovereign default in Sri Lanka as it had done in other countries, starting from post World War I Germany. (Sri Lanka’s Weimar Republic factor is inviting dollar sovereign default: Bellwether)
Sri Lanka’s economic consequences of the peace; monetary instability and trade lockdown: Bellwether
How Sri Lanka’s IMF-backed ‘Young Plan’ fired a foreign debt death spiral: Bellwether
Sri Lanka economy bought to tipping point by monetary fallacies: Bellwether
Sri Lanka posted a balance of payments surplus (foreign reserve collections of the central bank) from around September 2022.
Sri Lanka has posted current account surpluses amid foreign reserve collections by the private banks and the central bank over recent quarters.
Current account surpluses (or deficits) in the absence of central bank inflationary policy are neither good nor bad, but are a reflection of net domestic investment and the behaviour of the external financial/capital accounts.
However, any current account deficits worsened by open market operations, and a bureaucratic policy rate to target potential output or inflation tend to trigger external monetary instability.
The inflationary policy is reflected in giving foreign reserves for private imports, operationally as sterilizing outflows to suppress short term rates.
An SOE central bank however cannot give reserves for private imports on a net basis for any length of time without disturbing reserve money, triggering BOP deficits and mounting imbalances in credit and deposits which require steep rate hikes to correct.
Countries that depreciate currencies and destroy the real value of savings (inflate away savings) to impoverish savers, may be forced to borrow abroad triggering chronic current account deficits over long periods of time.
Countries with monetary instability and depreciating currencies also have high nominal interest rates. (Colombo/Dec03/2023)