Sri Lanka BOP troubles from wage hikes; no rampant monetization: Central Bank
ECONOMYNEXT – Sri Lanka’s central bank denied it was monetizing debt as large volumes of Treasury bills were taken in to its balance sheet to keep interest rates down and said the current balance of payments troubles came from a public sector wage hike.
"I don’t think there is any rampant monetization going on," Central Bank Governor Arjuna Mahendran told reporters.
"I see these comments in the press. As far as I am concerned we have been able to raise rupee liquidity from domestic savings on a largely non-inflationary basis over the last six months."
His comments came as the Central Bank’s Treasury bill stock (government debt in its balance sheet) rose to 170 billion by mid-September 2015 from just 5 billion rupees at the beginning of June.
In January the Central Bank had also financed the government through a so-called provisional advance.
Deputy Governor Nandalal Weerasinghe said the Central Bank had a "disciplined monetary regime" and denied that the current balance of payments crisis was generated by its releases of rupees in to the banking system.
"The balance of payments issue as you say is not necessarily because of all kinds of money printing," he said.
"It is partly because the government increased the wages and then there is an increase excessive demand."
Most analysts and economist would fully also agree that Sri Lanka’s current BOP crisis has been triggered by state salary hikes, since warnings were issued long before the problem reached towards a crisis.
But whether a profligate fiscal policy generates currency troubles or not is determined by the volume of accommodation of the deficit by the central bank through liquidity releases or outright printing of money.
When the additional purchasing power of newly minted money comes up for redemption in forex markets when they are disbursed as loans or paid out as salaries, the Central Bank has to defend the currency and redeem them by losing its foreign reserves or let the currency fall and generally destroy the purchasing power of all money and savings.
But Weerasinghe said reports on the level of money printing published in the media was a result of the ‘level of knowledge’ of the analysts and excess liquidity was down sharply from the 350 billion rupee levels seen last year.
In the month of September alone the Central Bank’s Treasury bill stock, which is a proxy for central bank credit creation went up from 91 billion rupees to 170 billion rupees and excess liquidity rose from 25.2 billion rupees to 70.7 billion rupees despite some liquidity being redeemed through forex reserve sales.
After a rate cut in April, foreign investors also started to sell out of Sri Lanka’s markets generating additional pressure. Foreign investors sell-out not just for interest rate arbitrage but also because they have no faith in the exchange rate peg, analysts say.
Sri Lanka has a so-called ‘soft’ or ‘non-credible’ peg to the US dollar where a central bank bank tries to control both the exchange rate and interest rates and frequently fails on both counts, when credit growth picks up.
The phenomenon has been seen in several pegged nations, except Hong Kong which is hard pegged and no money printing is legally possible.
Several Asian countries also have similar unstable monetary arrangements. Most so-called hard currency countries ended such arrangements after the Bretton Woods system of soft-pegs broke up and move to independently floating currency but the doctrine still lives on in Asia and Latin America.
Among those who had warned against central bank purchases of government debt was Goh Keng Swee, independent Singapore’s first Finance Minister who retained a currency board and opted not to buy Treasury bills. Singapore now has a modified currency board without a policy rate.
"Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster," he explained.
"There was no effective way of exchange control in an open trading economy like ours to deal with the inevitable balance of payments troubles.
"The way to a better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the work place. Diligence, education and skills will create wealth, not Central Bank credit."
The questions related to monetization is reproduced below:
Question: A related question about the budget. We have seen large volumes of debt being monetized and is fiscal policy a constraint for you to conduct monetary policy? What is your view on the wholesale monetization of debt that is taking place?
Governor: I will ask Mahinda Siriwardana to give us the statistics, but I do not think there has been any rampant monetization going on. You know I see these comments in the press. But as far as I am concerned one of the positive developments has been that we have been able to raise rupee liquidity from domestic savings on a largely non-inflationary basis for the last six months.
Deputy Governor: If you compare the past to now, for example now the amount of excess liquidity that is available in the market went up to more than 350 billion on a daily basis last year. We have been able to bring it down to more reasonable levels. It is a tighter situation now.
I have seen some of the media reports based on analysts’ level of knowledge that they say lots of money printing all those kinds of stuff. And it is up to those people to do that. But if you look at the overall numbers – and if that is the case – I mean if we have been printing so much of money and inflation is remaining zero percent I do not see the economics of that.
Basically if you look at the numbers it is very clear we had been having a very disciplined monetary regime here. We have been able to bring down the overall excess liquidity and also the monetary expansion in line with what we thought earlier in the year. And so as a result inflation is very much under control. If that is not the case and if we have been printing money so much then where is the result? I do not think there is any kind of validity of some of the arguments we are seeing in the media.
Question: Don’t you see the outcome in the BOP? In your foreign reserves in the currency?
Deputy Governor: The balance of payments issue, as you say, is not necessarily because of all kinds of money printing. It is partly because the government increased the wages. And then there is a wage increase and an increase in excessive demand – from public sector wage increases.
As a result you would have seen some monetary expansion. But still, that is within the limit we have announced on overall monetary expansion. That is why we have done some such adjustments on the external part – that is the external adjustment. That is I think I necessary instrument for us to curtail that excessive import demand. From time to time we use either interest rates or the exchange rate as an instrument to manage either the external demand of the domestic demand.
So that is the basic principle of monetary policy that we have been following. (Colombo/Sept29/2015)