ECONOMYNEXT – Interventions in Sri Lanka’s foreign exchange market by the central bank to maintain a soft-pegged exchange rate regime turns slightly negative in December after months of net purchases when private credit was negative, official data shows.
Central Bank net purchases of foreign exchange spiked to 162.5 million US dollars in July 2020 amid steep contraction in private credit.
Since then net purchases have fallen as private credit picked up.
Net purchases which were 93 million dollars in August, 2020 fell to 54 in September and 2.4 in November before turning to a net 22.5 million dollars of sales in December.
It is not unusual for pegged regimes to have small negative sales in some months amid credit spikes which makes liquidity tighten from dollar sales.
Sri Lanka however has over 200 billion rupees (about 20 percent of the monetary base) of excess liquidity.
Sri Lanka is operating a highly unstable pegged exchange rate regime aimed at collecting forex reserves without monetary policy to back it up or a transparent convertibility undertaking.
There is a notional weak side convertibility undertaking called a DMC rule (disorderly market conditions) which is found in highly unstable countries with monetary instability backed by International Monetary Fund programs.
The central bank also sold 174 million dollars in March 2020 after printing money through several means, and private credit spiked partly due to the fall in currency as importers scrambled to cover bills with a non-transparent DMC. The DMC was deployed close to 200 to the US dollar.
In December the central bank said it would like to see the rupee around 185 to the dollar and will take aggressive measures.
Sri Lanka’s foreign reserves which rose to 7.4 billion US dollars in August 2020 from 7.09 billion dollars in July had fallen to 5,549 million dollars by November.
The central bank had also executed swaps to temporarily borrow dollars, instead of buying them outright.
Swap premiums have turned negative amid record low rupee rates and weakened confidence after tax cuts and credit downgrades. Analysts say that Sri Lanka’s interest rates are now sharply out of line with balance of payments, though current transactions are not very strong amid weak private credit.
Sri Lanka’s stocks have been booming amid excess liquidity.
There are also import controls on items that bring high tax revenues to the government. (Colombo/Jan11/2021)