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Sri Lanka central bank buys US$162mn in July 2020 amid negative private credit

ECONOMYNEXT – Sri Lanka’s central bank has bought 162.5 million dollars from the interbank forex markets in July 2020 after negative private credit in May and June official data show.

Sri Lanka has also slapped severe import controls, not seen since the break-up of the Bretton Woods system in 1971 when the entire economy was closed. The contribution of the import controls make to negative private credit is not clear.

Sri Lanka’s forex reserves picked up by 400 million US dollars to 7.1 billion US dollars in July after a 500 million dollars swap from the Reserve Bank of India.

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The intervention data does not show official transactions, such as reserve appropriations to repay debt.

Sri Lanka’s highly unstable soft-peg with the US dollar came under severe pressure after record money printing in March and April 2020 coupled with a so-called ‘flexible’ exchange rate.

The ‘flexible exchange rate’ is a set of discretionary practices were foreign reserve sales interventions (which extinguishes excess liquidity injections and push up short term rates) are delayed for the peg to break and panic spread among importers who will then borrow and cover their bills early.

In March private credit surged to 100 billion rupees.

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The liquidity is injected (monetary stimulus) to target the call money rate as private credit begins to recover (pro-cyclical) from an earlier balance of payments crisis under a so-called ‘flexible’ inflation targeting to close a perceived output gap, at different levels of inflation.

In May and June private credit was negative, though the public sector deficit expanded as tax revenues fell partly due to a so-called ‘fiscal’ stimulus involving value added and other tax cuts.

In June the central bank also bought dollars on a net basis, purchasing 69 million US dollars and selling 9.25 million dollars.

By purchasing dollars the central bank can stop the currency appreciating as credit turns negative, in an explicit or implicit de facto real effective exchange rate targeting exercise.

Except after the 2009 crisis, the central bank has kept the exchange rate close to the level the peg had broken and prevented appreciation, in the worst record among South Asian monetary authorities.

During the March-April liquidity injection cycle the rupee fell from around 182 to close to 200 to the US dollar. It was then kept around 185 to the US dollar in July.

Over the last two weeks the rupee had been allowed to appreciate slightly.

All central banks in South Asia derive their currencies from Indian rupees or pegs to the Indian rupees at around 4.70 to the US dollar at the end of World War II.

The worst record is seen in Sri Lanka followed by Pakistan and Bangladesh. However Bangladesh central bank has followed better policies for over a decade, keeping the exchange rate stable, allowing strong phase of growth.

Bhutan and Nepal does not practice interventionist monetary policy and has kept strong pegs, bt fixed to the India rupee, where the Reserve Bank of India has bad policy.

The most monetary stability has been provided by the Monetary Authority of Maldives, where per capita income is now over 11,000 Us dollars. (Colombo/Aug17/2020)