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Wednesday December 6th, 2023

Sri Lanka central bank busts US$9.8bn since Feb 2020 to suppress rates, for stimulus

ECONOMYNEXT – Sri Lanka’s central bank has spent 9.8 billion US dollars in reserves, including about 4.48 billion US dollars in borrowed money in the process of maintaining artificially low interest rates while operating a reserve collecting peg, data show.

Sri Lanka intensified stimulus (output gap targeting) from 2020 intensifying a policy broadly followed under flexible inflation targeting over the previous five years which triggered two currency crises in 2015/2016 and 2018, under a flexible exchange rate or soft-peg, which reduced growth (output).

The International Monetary Fund itself had given technical assistance for the trigger happy central bank to calculate an output gap.

Output Gap Targeting/Flexible Inflation Targeting

In December 2019 Sri Lanka’s state economists cut taxes saying there was a ‘persistent output gap’ in fiscal stimulus and followed it up with rate cuts and liquidity injections to stop rates from going up.

In February liquidity injections began including with a central bank profit transfer.

At the time the central bank had net reserves of about 5.3 billion US dollars and Sri Lanka had gross official reserves 7.9 billion US dollars which included borrowings from the International Monetary Fund and any fiscal balances.

In March the currency fell steeply under a zero-credibility flexible exchange rate but the peg stabilized in the Coronavirus lockdowns and credit slowdown that followed.

Large scale liquidity injections were the made for a ‘fuel price stabilization fund ‘and also to meet a real demand for money during the lockdowns.

The central bank then imposed ceiling on Treasuries auctions effectively operating ceiling policy rates across the yield curve and scuttling Treasuries auctions wholesale.

Large volumes of money was injected to re-purchase government securities from scuttled auctions under so-called Modern Monetary Theory and the central bank lost its ability to collect reserves (sterilize or mop up inflows) to repay debt and its reserves were depleted.

As economic activity and private credit recovered the central bank steadily lost reserves to debt repayment.

In 2015/2016 and 2018 Sri Lanka’s government and the Ceylon Petroleum Corporation borrowed heavily from commercial markets and banks as liquidity injections created forex shortages.

But after 2020 Sri Lanka lost access to commercial banks. After a series of downgrades there was also capital flight from the banks.

The central bank then started to borrow more dollars through international and domestic swaps, without allowing rates and liquidity to tighten to stop the reserve outflow.

Monetary Finance of Imports

Meanwhile from around late 2021, economists outside the central bank also called for reserves to be used for imports, at whatever the pegged rate.

A central bank with a policy rate which gives reserves for imports then sterilizes the dollar sales with adding new money to the banking system to suppress interest rates (soft-peg) effectively engages money financing of imports and private sector activity, by preventing a tightening of bank liquidity.

In order to maintain the credibility of the peg and monetary stability interventions have to be unsterilized or at least partially unsterilized with liquidity tightening and rate moving up.

Related

Sri Lanka continues monetary financing of imports, pegging after ‘running out’ of reserves

By December 2021 imports shot up to 2.2 billion US dollars a month as interventions around 300 to 400 million US dollars a month were made.

Calls to use reserves for imports (soft-peg) continued to intensify from economists and others outside the central bank, though by September 2021 the central bank was using borrowed money to finance imports.

Those who called for reserves to be used for imports, which necessarily involve pegging at the intervention rate for imports, simultaneously called on the central bank not to peg in an unusual monetary irony.

Borrowing for imports

Sri Lanka is currently using borrowed US dollars from India under the Asian Clearing Union to intervene and operate a peg at 360 to the US dollar.

Sri Lanka’s central bank however raised rates in April, in a bid to reduce or end money printing and allow rates to go up and private savings to be directed to the budget deficit after a collapse of the currency from200 to 360 to the US dollar and from 182 since the stimulus began.

Maturing debt can also be rolled over as paper at higher rates.

The collapse of the currency and the spike in interest rates is referred as ‘rawluth ne kendeth ne’ (neither the interest rate nor the exchange rate is saved in the end) by critics.

Sri Lanka’s central bank was about 4.48 billion US dollars debt by June having spent 9.8 billion US dollars since February 2020 to finance imports, finance debt repayment and also some other capital flight as investors exited due to the loss of the credibility usually found in flexible exchange rates or soft-peg.

Soft-pegs (flexible exchange rates) were built by mainly US based officials including Harry Dexter White and John H Williams in the course of building the Bretton Woods system of failed pegs in the false belief that there was monetary policy independence in pegging to an anchor currency.

Pegs around the world, which are trying to operate credit cyclical counter to that of the peg are now under pressure as anchor reserve currencies as the US dollar is raising rates.

Analysts have called for strict controls on the domestic operations (issued department activity of a note issue bank) of Sri Lanka’s monopoly note issue bank to maintain monetary and social stability.

However attempts are being made to legalize flexible inflation targeting with flexible exchange rate that drove the country at peace into three currency crises and default with discretionary policy and severe anchor conflicts.

Forex shortages and currency crises are a problem associated with flexible exchange rates or soft-pegs with anchor conflicts and are absent in consistent single anchor regimes such as clean floats (domestic anchor only) and hard pegs (external anchor only). (Colombo/Aug01/2022)

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  1. Anonymous says:

    Cabraal is a qualified Chartered Accountant (FCA) in Sri Lanka. But the professional body has not done anything to expell him from their membership on his wrong behavior. The professional body is protecting him and is leading a bad example for many Chartered Accountants working worldwide in different companies on their ethical behavior.

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  1. Anonymous says:

    Cabraal is a qualified Chartered Accountant (FCA) in Sri Lanka. But the professional body has not done anything to expell him from their membership on his wrong behavior. The professional body is protecting him and is leading a bad example for many Chartered Accountants working worldwide in different companies on their ethical behavior.

Sri Lanka rupee closes stronger at 327.40/90 to the US dollar

ECONOMYNEXT – Sri Lanka’s rupee closed at 327.40/90 to the US dollar on Tuesday, from 328.10/30 the previous day, dealers said.

Bond yields were stable.

A bond maturing on 01.06.2025 closed at 13.60/70 percent from 13.70/14.00 percent.

A bond maturing on 01.08.2026 closed at 13.90/14.00 percent from 13.90/14.10 percent.

A bond maturing on 15.01.2027 closed at 14.00/15 percent from 14.00/14.10 percent.

A bond maturing on 01.07.2028 closed at 14.10/20 percent from 14.20/35 percent.

A bond maturing on 15.05.2030 closed at 14.20/35 percent, from 14.25/45 percent.

A bond maturing on 01.07.2032 closed at 14.10/35 percent, from 14.05/40 percent. (Colombo/Dec5/2023)

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Sri Lanka stocks close down as investor sentiment dips

ECONOMYNEXT – The Colombo Stock Exchange closed down on Tuesday, CSE data showed.

The All Share Price Index was down 0.40 percent, or 43.50 points, at 10,700.09.

The S&P SL20 index was up 0.43 percent, or 13.32 points, at 3,054.41.

Turnover was at 711 million. The capital goods sector contributed 172 million, the food, beverage and tobacco sector contributed 140 million, and banks 113 million of this.

Top positive contributors to the ASPI in the day were John Keells Holdings Plc (up at 193.00), Richard Pieris And Company Plc (up at 19.80), and Nation Lanka Finance Plc, (up at 0.40).

Negative contributors were Commercial Bank of Ceylon Plc (down at 89.70), Sampath Bank Plc (down at 71.00), and Central Finance Company Plc, (down at 106.00). (Colombo/Dec5/2023).

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Sri Lanka plans to reduce number of school grades from 13 to 12

ECONOMYNEXT – The Ministry of Education proposes to reduce the number of school grades from 13 to 12, according to a government information department statement.

“Every child will be given the opportunity to finish school in 17 years through the proposed new education reforms,” education officials were quoted as saying after a discussion on budget allocations.

Under the proposed system, pre-school education will be at the age of 4 years, the primary section between grades 1-5, junior section between grades 6-8, and senior section between grades 9-12.

The General Certificate of Education Ordinary Level Exam (GCE O/L) is proposed to be conducted in grade 10, and the Advanced Level Examination in grade 12.

It has also been decided to reduce the number of mandatory subjects at the GCE O/L Exam from 9 to 7.

Three new subjects, information and communication technology (ICT), technical and professional skills, and religion and values will be made mandatory and included in those 7 subjects. (Colombo/Dec5/2023)

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