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Wednesday October 5th, 2022

Sri Lanka CB Governor meets envoy of forex reserve rich Bangladesh

A MORE CREDIBLE PEG: Bangladesh reserve money grew above target as the Taka was prevented from appreciating amid a slowdown in domestic credit which slowed outflows. The liquidity from NFA sharply lowered overnight rates. Similar outcomes were seen in stable pegs such as Vietnam where the overnight rate was allowed to fall to 0.2 percent.

ECONOMYNEXT – Sri Lanka’s central bank Governor Ajith Nivard Cabraal has met the High Commissioner for Bangladesh in Colombo, whose central bank has extended a 200 million US dollar swap to the island.

Governor Cabraal and the High Commissioner Tareq Md Ariful discussed “strengthening of economic ties and greater utilization of the Colombo Port for Bangladesh exports.”

Bangladesh Bank, the country’s central bank has given a 200 million US dollar swap to Sri Lanka’s central bank which has seen a run on its forex reserves as liquidity was injected into money markets to suppress rates.

As domestic credit slowed amid a Coronavirus pandemic, Bangladesh Bank (BB) has collected billions of dollars of new foreign reserves, in line with other countries that also have fairly credible pegs.

Bangladesh Bank runs a reserve money program with less discretionary power, compared to Sri Lanka which is operating a ‘flexible’ inflation target with contradictory domestic and external anchors and a obsessive control of short term rates with excess liquidity.

Backed by the credible peg Bangladesh’s balance of payments recorded a “sizeable surplus” of 9.2 billion US dollars up to June 2021 compared to 3.129 billion US dollars a year earlier, the central bank said.

“Relying on the this BoP surplus net foreign assets of the banking system saw a very strong growth of 275 percent alongside reaching BB’s foreign exchange reserves to a historically high level of USD 46.4 billion at the end of June 2021,” Bangladesh Bank said.

BB has kept is product, the Taka, around 83 to 84 to the US dollar from 2012, with monetary policy to support it, giving a strong foundation for stability and growth.

It follows a reserve money targeting exercise (a type of domestic anchor) which is more complementary to foreign reserve collection, though the peg can collapse if outflows are sterilized to keep rates down (reserve money starts to grow with acquisitions of domestic assets, which then drive private credit and outflows).

The last such collapse happened in 2010/2011 when the Taka fell to 83 from 68 to the US dollar.

In sharp contrast Sri Lanka follows a ‘flexible exchange rate’ an unusually non-credible peg with extreme anchor conflicts while printing money to push domestic inflation up to 6 percent, but frequently missing it and pushing it above that in many months.

In the same period Sri Lanka with a combination of call money rate targeting, high inflation targeting, real effective exchange rate targeting, has triggered four crises in 2011/2012, 2016/2016, 2018 and 2020/2021 which is ongoing.

The on going crises was engineered mostly with price controls on bond auctions and outright purchases of government securities.

In 2020 March as the currency fell sharply in a so-called sudden ‘flexible exchange rate episode’ with unusual helicopter drops of liquidity, panicking importers as usual, the Sri Lanka was downgraded.

As private credit collapsed amid lockdowns, the like Bangladesh Sri Lanka’s central bank also bought dollars and collected foreign assets but as private credit recovered more money was printed to keep rates down, hitting the exchange rate, triggering forex reserve losses.

Sri Lanka’s domestic credit is largely driven by a massive budget deficit coming from tax cuts in December 2019 driven by ‘stimulus’ ideology.

Rates were also suppressed due to ‘stimulus’ ideology. (Colombo/Sept26/2021)

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