ECONOMYNEXT- Sri Lanka central bank’s last month policy rate hike has not met its real objective of making export credit expensive and allocating more funds to green energy initiatives, President Secretary P B Jayasundera said.
Sri Lanka’s central bank in August raised its overnight rate at which money is printed to 6.0 percent from 5.5 percent and also doubled the statutory reserve ratio (SRR) to 4.0 percent taking out around 150 billion rupees from banks and parking them at the central bank.
The SRR is the share of deposits commercial banks has to place with the central bank.
Analysts had pointed out that Sri Lanka’s interest rates across the yield curve, as well as deposit rates were out of line with the budget deficit, and central bank purchases of bill and bonds at price controlled auctions were injecting liquidity at different policy rates.
The money, or notes issued as interest free liabilities of the central bank, when used to finance budget spending or re-finance private credit has depleted the foreign assets of the central bank as the new notes were redeemed against dollar reserves to maintain an exchange rate peg.
Many banks including state banks, which had given domestic credit without sufficient deposits were already short of cash, and were borrowing from the central bank window when the SRR was doubled.
The new liquidity short was again filled with central bank money at 6.0 percent.
Jayasundera, the country’s top public official and former finance secretary who still has strong influence in economic policies said the real intention was different.
Expensive Export Credit
“It was requested that the interest rates on export credit be raised, but instead of that they raised the other interest rates,” Jayasundera told EconomyNext in an interview.
“There have been lower interest rates and the lower interest rates have been used for the finance export credit and as a result they are not bringing in foreign exchange.”
“If the export credit is expensive, they have to bring dollars,” Jayasundera said.
Sri Lanka’s ex-Central Bank Governor W D Lakshman had said the central bank had to work in co-ordination with the Treasury.
The central bank also has the Treasury Secretary as a member of the rate setting monetary board.
The low rupee rates, which are still below inflation, not only encourage exporters not to convert dollars and use rupee credit to fund spending, but also encourage importers to hold stocks analysts say.
Sri Lanka’s central bank tightens controls on exporters every time it prints money and creates balance of payments troubles.
When money was printed under the last administration in 2015 and 2016 amid widening deficit then Finance Minister Ravi Karunanayake and the central bank also blamed exporters and placing a 90-day rule drawing protests as sometimes long credit periods had to be given to win business.
Related: Sri Lanka relaxes newly imposed exchange control
Engaging in a similar blame game the central bank said this month there was a discrepancy between customs data and that “exporters on average do not bring nearly a third or 345 million dollars of their export earnings into the country, raising “serious question as to whether exporters comply with the regulation on 100 percent repatriation of export proceeds.
“In addition, with low rupee interest rates, some exporters have found it more lucrative to borrow and import to meet their input requirements, leading to further tension in the domestic market,” the central bank however admitted.
Low interest rates and liquidity injections also fire asset price bubbles. Inflationary expectations are openly promoted by stock punters now who promote companies with ‘dollarized assets’ expecting the rupee to collapse further.
Foreign investor have also happily sold stocks at high prices, which local investors bought, including on margin credit, perhaps re-finance with printed money from failed bond auctions.
None of the actions however will impact the exchange rate, if the credit was funded by real deposits at (curbing other consumption and investment and therefore imports) at a market rate structure, where there is no mis-directed price system, analysts say.
Exporters and importers are able to fund the expenses and the public does not have to save, since the credit is funded by either central bank window money or liquidity created from price controlled bond auctions, analysts say.
Before a central bank which could print money to enforce a policy rate and trigger currency crises was set up in 1950 by a Federal Reserve official, Sri Lanka had a fully credible peg at 4.70 to the US dollar (1 to 1 with the Indian rupee) from 1885.
Packing credit rates were hiked by then-Governor A S Jayewardene as part of measures to counter a currency crisis in 2000/2001, prior a float of the currency to end sterilized intervention, along with a steep rate hike.
He also said the central bank has not been monitoring of foreign flows in commercial banks.
“Strangely, none of the foreign exchange transactions are monitored by the central bank,” he said.
Jayasundera’s statement was made before Nivard Cabraal was reappointed the central bank Governor.
However in countries with good central banks which provide monetary stability there are no exchange controls of any type and exporters are not harassed by authorities, as long as income is declared for tax purposes, analysts say.
Central Bank Re-Finance
Jayasundera said the SRR hike was requested not to drain liquidity but to channel funds for green energy.
“There has also been a request to increase the SRR not to tighten the liquidity, but to use that increase to channel for renewable energy and green energy transformation,” he said.
“That has not been done yet.”
The central bank injected 103.5 billion rupees at a weighted average yield of 6.13 percent, below the market 3 month average of 6.38 percent to reverse part of the SRR hike.
Any money taken by the SRR, which is the margin a commercial bank must keep at the central bank against its deposits, become a cost to banks, which has to raise deposits at market rates.
If SRR money is again released to banks, it has the same effect as deposits being used for a directed lending scheme.
If the liquidity short is by this time filled for 87 days with term reverse repo money, the new green lending could again trigger a forex shortage, a fall in the currency, or a fall in foreign reserves if the exchange rate is maintained, analysts say.
Sri Lanka has in the past depreciated the currency after rural credit was given through central bank re-finance (printed money) under Section 88/88A of the Monetary Law, which some analysts blame for the failure to maintain monetary stability after then-President J R Jayewardene’s re-opened the economy.
Section 88/88A was not part of the original law of John Exter, where the rupee was fixed at 2.88 grains of gold.
Section 88 was only for provisional advances which were also limited to 180 days. However they are now issued to perpetuity through an accounting gimmick and the central bank is buying long term bonds into its balance sheet.
“Many central banks and national economies have come to grief because government’s had too easy access to central bank credit,” Exter wrote prophetically in his 1949 report to set up a central bank and end the currency board which had kept the economy stable through two World Wars and one Great Depression.
Similar provisions had been used by the Reserve Bank of Zimbabwe to create forex shortages and hyper-inflation. Sri Lanka also used Section 88 to give Saubhagya Covid loans. Another such scheme had been requested for state enterprises.
Central Bank Governor A S Jayewardene halted the rural credit re-finance as part of efforts to stop high inflation and currency depreciation after he became Governor in 1995, though Section 88 was not repealed.
The central bank had already started to raise rates, when he was Treasury Secretary.
Governor Jayewardene also spun off a network of rural development banks in 1997, cutting their direct link to the central bank.
One of the first acts of China’s reformers under Deng Xiaoping in 1978 was also to create separate commercial banks from the People’s Bank of Chinas’ industrial, agricultural and construction finance units.
Industrial and Commercial Bank of China (ICBC), the Bank of China (BOC), the Agricultural Bank of China (ABC), and the China Construction Bank (CCB).
After a severe currency crisis in 1988/89 when foreign reserves fell to 14 billion US dollars amid US monetary tightening and another in 1993, the People’s Bank of China law was further tightened to prohibit state enterprise re-finance and similar financing.
Vietnam, whose economy also imploded from soon after re-opening in 1986 as the Dong collapsed amid surging credit, reformed State Bank of Vietnam and spun off its credit operations into deposit taking commercial banks.
These included Vietnam Joint Stock Commercial Bank for Industry and Trade (Vietinbank) now listed in the Ho Chi Minh Stock Exchange and part owned by Mitsubishi UFJ of Japan and the Vietnam Bank for Agriculture and Rural Development. (Colombo/Sept30/2021)