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Sunday December 3rd, 2023

Sri Lanka can cut rates now, keeping them down as credit picks up will hit rupee: Bellwether

RESERVE: Maintaining and exchange rate anchor at zero is the most simple monetary regime. Currencies collapse due to inflationary market operations, not due to imports or capital flight.

ECONOMYNEXT – Sri Lanka can cut policy rates now as private credit is negative, but should be prepared to allow interbank rates to go up as the economy recovers, to avoid economic reforms being discredited and the public from being pushed into poverty through monetary instability.

A slide in the currency will push up energy and food prices, denying monetary stability to the poor, make it difficult to run energy utilities, and lead to calls for subsidies as well as loss of investor confidence and capital flight.

Reformist governments are time and again ousted under International Monetary Programs and market economies are discredited due to monetary instability which come from anchor conflicts that worsened from the 1980s.

Denying monetary stability to a country through soft—pegging, or flexible exchange rates and covering them up with import and exchange controls have been the main plank of Sri Lanka’s economic policy frameworks in the post-independence era.

Such policies were rejected by Japan in the immediate post World War II era, China and Vietnam after its economy imploded in the 1980s, and were never followed by countries like Singapore or Malaysia.

There is no future in denying monetary stability to the people.

Sri Lanka’s central bank in recent months have been following good monetary policy with a slight hiccup in exchange rate policy up to now, allowing public confidence in reforms to build up as they did in the UK after 1979.

Can Sri Lanka cut rates now?

Yes. All rates should be cut this year. After private credit starts to pick up rate cuts should be avoided. Instead, short term rates should be allowed to go up temporarily as and when required.

How can the central bank avoid mis-targeting rates as in the past?

The best way is to cut the policy floor steeply and avoid cutting the reverse repo rate at the same pace. That way the policy corridor will be wide and rates will naturally fall towards the lower policy corridor as long as long as credit is moderate. This has happened in the wake of a successful float and re-pegging in past currency crises.

However, for that to work, some excess liquidity has to be allowed to be built up from dollar purchases. Then a part of the liquidity from dollar purchases has to be mopped up by outright sales of central bank held treasury securities.

As long as a part of the liquidity from dollar inflows are mopped up, the balance of payments would be in surplus.

But if there are temporary increases in credit and import or capital outflows, the central bank has to sell dollars.

If not, panic will set in the market as happened last month when the exchange rate went up violently from 290 to 320 due the lack of a consistent exchange rate policy.

The central bank was able to intervene minimally since the underlying monetary policy was deflationary and there was a BOP surplus due to sell-downs of central bank held securities.

But if underlying credit conditions are strong, rates have to go up with interventions. If not th

A wide policy corridor of about 5 percent or more is useful. A higher reverse repo rate will raise the costs of over-trading banks. Vietnam is now following a similar policy after putting the brakes on credit to stabilize the currency.

Since the central bank has been given a reserve target by the IMF, pegging cannot be avoided. The most-simple rule to avoid mis-targeting rates, and going for a second default, is to allow rates to go up if BOP deficits emerge.

Depreciating the currency and destroying purchasing power of the poor and trying to collect reserves have to be avoided. East Asian countries collected saving that people had already set aside at a fixed exchange rate.

The central bank is keeping the market short now. Isn’t that a better policy?

The central bank is now selling Treasury bills in fixed amounts. If dealers or banks buy them with window money or running reserve shorts, a liquidity shortage develops.

This shortage is then filled with term and overnight reverse repo injections. This action disturbs rupee reserves in individual banks and encourages banks to overtrade and trigger forex shortages later.

It may also prevent rates from falling faster, naturally. However it has worked so far.

The best course of action is to wean banks away from liquidity facilities and encourage them to follow the prudent practice of giving loans or buying securities only with deposits as is done in all successful East Asian countries with stable or absolutely fixed exchange rates.

The central bank should consider rolling-over its holdings and sell down marginal amounts at auctions.  Encouraging primary dealers or banks to borrow from central bank tools for anything other than overnight is not prudent.

At the moment complex open market operations are being done both ways, which can easily backfire as credit picks up.

What about longer term money?

Longer term money should not be given at the overnight policy rate. Longer term money should be given at a slightly higher rate, above the deposit rates, especially after credit picks up.

After credit picks up, injections should be avoided. If not, reserve targets will be missed, the currency will fall or both.

Did the IMF always deny monetary stability through depreciation?

No. The IMF was set up to maintain stable exchange rates in the post-World War II era. It gave stand-by facilities and advocated policies to minimize exchange rate depreciation while allowing some deviation from the original Bretton Woods rates when currencies were pressured from fixed policy rates or active macro-economic policy.

But the system was based on a flawed understanding of credit systems that developed in the 1920s primarily among Anglofone academics.

The Bretton Woods was set up after currencies started devaluing in the 1930s (went off the gold standard) mostly due to the fixed policy rate and it led to an epidemic of protectionism.

Under the Bretton Wood regime there were two independent but complementary anchors in the form of gold and the US dollar to work with. Until 1971 inflation and interest rates were in the single digits or low single digits.

After the collapse of the Bretton Woods in 1971 due to the rise of macro-economic policy (read non-market fixed policy rate) in the 1960s, the Western central bankers started to play around with money supply targeting.

Money supply targeting was relatively successful as long as there was a clean float and essentially helped end the Great Inflation of the 1970s that came from fiat currencies.

Positive Inflation targeting which emerged in the 1990s turned out to be easier to operate in practice than money supply targeting, but was a weaker standard than the targeting gold at zero.

Countries that tried money supply targeting while trying to collect forex reserves (without a floating exchange rate) ended up with forex shortages and depreciating currencies and high inflation as domestic and external anchors conflicted.

The UK also had similar problems in the 1970s – including within IMF programs – leading to wide public discontent and strikes.

The IMF is now promoting inflation targeting without a floating exchange rate leading to similar anchor conflicts as money supply targeting without a floating rate did before 1990s

Dual anchor conflicting regimes lead to the same consequences  – forex shortages and currency depreciation. Steep depreciation in the wake of liability dollarization will lead to a sovereign default.

Sri Lanka’s central bank has done well to allow the currency to appreciate, leading to wide public contentment as they see the early benefits of monetary stability flowing into their lives. The falling energy prices under Thatcher-Howe monetary reforms were similar.

The so-called Washington consensus failed because monetary stability was out of the reform frameworks.

If the currency starts to slide as in previous failed IMF programs due to the fixed policy rate as central banks went off the gold standard in the 1930s, and the collapse of the Bretton Woods later, the opposite will happen.

The situation in Surinam and some other countries including Pakistan and Bangladesh should be a lesson.

What about the flexible exchange rate?

The flexible exchange which is not a clean float but a flawed regime, is not backed by a  consistent set of policies.

Flexible exchange rates and flexible inflation targeting try to defy the law of nature discovered and described by classical economists like David Ricardo, David Hume and more recently by Robert Mundell and Marcus Fleming among others.

What was seen in the last month was that despite relatively good monetary policy, the rupee fell steeply. The resulting public reaction showed how easily people will lose faith in the IMF program and reformist administrations.

The central bank is nothing but an bank that collects dollars from the domestic economy and invests or lends them to the US via its reserves. As said before it is best to collect the savings people had set aside than destroying their purchasing power by depreciation.

Single anchor regimes, whether fixed or floating, leads to low single digit interest rates and low debt to GDP ratios. (Colombo/July05/2023)

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  1. sacre blieu says:

    The buying power of the rupee should be returned to the pre-crisis level, due to the the very many having lost value of their savings and the meagre income they now receive. The huge amount of printed money has seen the bulk of it finding its way to the top 5 to 8 % of the financial regime., moistly the fraudsters.

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  1. sacre blieu says:

    The buying power of the rupee should be returned to the pre-crisis level, due to the the very many having lost value of their savings and the meagre income they now receive. The huge amount of printed money has seen the bulk of it finding its way to the top 5 to 8 % of the financial regime., moistly the fraudsters.

UAE investors express interest in Sri Lanka’s energy, tourism, ports, real estate: Ali Sabry

ECONOMYNEXT – A group of investors based in the United Arab Emirates have expressed their interest in renewable energy, tourism, ports, and real estates, Foreign Minister Ali Sabry told Economy Next.

A Sri Lankan delegation led by President Ranil Wickremesinghe is in Dubai to take part in the 2023 United Nations Climate Change Conference (COP28).

Sabry said a group of large investors met the President on Friday and discussed possible opportunities in Sri Lanka.

“We met big investors here particularly on renewable energy, tourism, port development and also infrastructure development and real estate. That’s where they are doing very well,” Foreign Minister told Economy Next.

“Our embassy will organize a higher-level business delegation to visit Sri Lanka to look at the available opportunities.”

“There is a lot of traction and interest in Sri Lanka.”

Sri Lanka has been exploring to attract investors to crisis hit Sri Lanka which declared bankruptcy in April last year with sovereign debt default.

Since then, most investors have taken a step back from investing in the island nation due to its inability to serve debts and uncertainty over such investments.

Several government officials said investors may start pouring dollars into Sri Lanka very carefully after they see some certainty of debt repayments. (Dubai/Dec 3/2023)

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Sri Lanka to push for green initiative investment “after OCC finalizing” debt deals – President

ECONOMYNEXT – Sri Lanka will push for investment into green initiatives globally after the Official Creditor Committee (OCC) finalizing on the island nation’s debt restructuring, President Ranil Wickremesinghe told Economy Next at the 2023 United Nations Climate Change Conference (COP28).

President Wickremesinghe along with local and global advisors has inaugurated three ambitious projects to convert climate change-led disaster funding, which is mostly seen as donations, into viable commercial enterprises involving private sector investments.

The idea is to rally all the global nations in the Tropical Belt threatened by disasters related to climate change and bargain collectively with advanced economies which emit more greenhouse gases into the environment resulting in global warming for more green initiatives like renewable energy projects.

Wickremesinghe initiated a Climate Justice Forum (CJF), Tropical Belt Initiative (TBI), and called on the world to help establish the International Climate Change University in Sri Lanka.

His moves have been welcomed by global leaders, though analysts said an initiative like TBI is a “bold and imaginary” step.

“This is the first step. We have now put forward the proposal,” Wickremesinghe told Economy Next on Sunday on the sideline of the COP28 in Dubai’s EXPO 2020.

“There is an interest. We have to wait for OCC finalizing (debt restructuring) before pushing for investments.”


Global investors are hesitant to invest in Sri Lanka due to its bankruptcy and sovereign debt default.

Sri Lanka is still recovering from an unprecedented economic crisis which has compelled the island nation to declare bankruptcy with sovereign debt default.

President Wickremesinhe during a forum on Saturday said his initiatives would help government in advanced countries not to use tax money of its own people for climate related disasters in other countries and instead, private sector investors could help by investing in renewable energy initiatives.

President Wickremesinghe’s government has been in the process of implementing some tough policies it committed to the International Monetary Fund (IMF) to stabilize the country and ensure sustainability in its borrowing.

Sri Lanka is yet to finalize the debt restructuring fully as it still has to negotiate on repayment schedule of commercial and sovereign bond borrowing.

The OCC and Sri Lanka had agreed on the main parameters of a debt treatment consistent with those of the Extended Fund Facility (EFF) arrangement between Sri Lanka and the IMF.

The members of the Paris Club which are part of the Official Creditor Committee are representatives of countries with eligible claims on Sri Lanka: Australia, Austria, Belgium, Canada, Denmark, France, Germany, Japan, Korea, the Netherlands, Russia, Spain, Sweden, the United Kingdom, the United States of America.

The OCC has said it was expecting other bilateral creditors to consent to sharing, in a transparent manner, the information necessary for the OCC to evaluate comparability of treatment regarding their own bilateral agreement.

The OCC also has said it expects that the Sri Lankan authorities will continue to engage with their private creditors to find as soon as possible an agreement on terms at least as favourable as the terms offered by the OCC. (DUBAI/Dec 3/2023)

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Sri Lanka alcohol regulations may be spurring moonshine: Minister

ECONOMYNEXT – Sri Lanka’s alcohol regulations may be reducing access to legal products and driving illegal moonshine sector, State Minister for Finance Ranjith Siyambalapitiya said amid plans to change opening times of retail outlets.

Sri Lanka is currently discussing changing the opening times of bars (retail alcohol outlets), he said.

Sri Lanka’s excise laws may be contributing to the growth of illegal products, Minister Siyambalapitiya was quoted as saying at the annual meeting of Sri Lanka’s excise officers.

Over 20 years legal alcohol sales have grown 50 percent but illegal products are estimated to have grown 500 percent, he said.

It is not clear where the 500 percent estimate came from.

In Kandy there was a bar for every 6,000 persons but in Mullativu there was one for only 990,000 persons and people had to travel 80 kilometres to get to a legal outlet, Minister Siyambalapitiya had said.

However Sri Lanka has a widespread moonshine or ‘kasippu’ industry driven by high taxes on legal products.

The widely used ‘gal’ or special arrack is now around 3,500 rupees and may go up further with a hike in value added tax. About 2000 rupees of the sale price is taxes.

After a currency collapse and tax hikes legal alcohol sales have fallen, leading to local sugar companies burying ethanol, according to statements made in parliament.

An uneven distribution of bars may also be driving people towards alcohol.

Alcohol sales is controlled on the grounds that it is an addictive product which can lead to poverty, ill-health, bad behaviour and criminal activities, though advocates of high taxes ignore the poverty angle.

High taxes are promoted by temperance movements some of whom have called for outright prohibition in the last century.

Temperance movements spread among evangelical groups in the West and were also embraced by nationalists/moralists and independence movements in colonial authorities.

Prohibition in the US however led to more criminal activity as an organized crime took to bootlegging. (Colombo/Dec03/2023)

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