ECONOMYNEXT – Sri Lanka’s central bank held Treasury bill stock, the largest domestic asset stock, reached 1,135.5 billion rupees after a billion dollar sovereign bond and coupon was re-paid, avoiding default, but it also led to a further decline in foreign assets.
The bill stock went up from 922 billion rupees.
On Thursday, there were further large reserve outflows.
In addition to the Treasury bills, the central bank has also advanced another 198.2 billion rupees by so-called ‘provisional advances’, which is an interest-free printed money overdraft facility.
Similar provisions are found in several central banks that suffer serious foreign exchange problems, including Bank Indonesia, analysts familiar with the issue say.
Advances were given by what was called Bank Negara Indonesia Unit 01, after the earlier private and stable note-issuing Java Bank, which kept monetary stability for 125 years, was nationalized.
Money printing started in independent Indonesia in a fit of Keynesianism or post-Keynesianism which was spreading like a new religion.
Under Sri Lanka’s Latin America style monetary law devised by a Fed ‘money doctor’ in 1950 up to 10 percent of expected state revenue can be printed at the beginning of the year. It had a three member Monetary Board.
“The device of setting up a policy-making board on which the Minister of Finance, or his representative, and the Governor of the Bank serve as co-equals had already been introduced in the Philippines and Ceylon, and the experience of these countries may have suggested this solution in Indonesia,” economist Reed J Irvine wrote in a 1953 Federal Reserve Bulletin.
When Sri Lanka had monetary stability before 2011, such advances (liquidity) were immediately mopped up by the central bank’s domestic operations department before they led to forex reserve losses or domestic credit.
In the early days, officials with classical economic knowledge in Indonesia dating back from Java Bank tried to offset profit transfers against provisional advances from BNI unit 1 to reduce liquidity injections and protect the currency. It could monetize up to 40 percent of previous years tax collections through advances.
“The Indonesia Rupiah started to collapse rapidly as old Java Bank officials retired,” EN’s economic columnist Bellwether says.
“This was similar to the collapse of the Sri Lanka rupee after Governor A S Jayewardene and Deputy Governor W A Wijewardene retired.”
Since Wijewardene retired the rupee has collapsed from around 113 to 203 to the US dollar.
In in Sri Lanka June there was a nine days wonder when the provisional advances were reversed to meet a six-month deadline with media reports saying a large volume of money was printed, though such book entries do not result in liquidity or a foreign reserve change for a second time.
Analysts have called for changes to Sri Lanka’s monetary law to mandate strict constraints on domestic operations to prevent forex shortages, currency collapses and possible sovereign default.
The calls intensified as policy deteriorated sharply during the last administration with discretionary ‘flexible’ exchange rate (non-credible external anchor), ‘flexible’ inflation targeting (non-credible domestic anchor.
When injected liquidity triggers demand and imports foreign reserves have been spent to defend a peg (a convertibility undertaking) and ‘redeem’ the new rupees (provide convertibility) leading to a loss of reserves.
#SriLanka‘s #Rupee faces crisis after crisis because it operates a flexible #ExchangeRate backed by contradictory money & exchange policies. As I advised President Suharto of #Indonesia in ’98, the only options are to #dollarize or est. a currency board.https://t.co/k0tC8RZtEM
— Steve Hanke (@steve_hanke) September 10, 2019
If no convertibility is provided the peg will break (the rupee will depreciate). Sri Lanka rupee was originally pegged to gold at 2.88 grains when the central bank was set up in 1950 with the peg to the US dollar.
The US dollar at the time was pegged 35 dollars an ounce of gold when the Bretton Woods system was started after World War II.
However, due to output gap targeting (a type of monetary stimulus also followed in Sri Lanka under the last IMF program), the US dollar also collapsed in 1971 ending the gold standard and the Bretton Woods system, leading to a floating exchange rate after President Nixon closed the gold window (ended convertibility)
The rupee collapsed from 131 to 182 under output gap targeting. Since 2020 Sri Lanka is under Modern Monetary Theory and the BOP deficit (before July payments) was over 3 billion US dollars. (Colombo/July28/2021)