Sri Lanka central bank forex purchases decline as credit picks up

ECONOMYNEXT – Sri Lanka’s central bank bought 7.4 million dollars from forex markets in November and sold 5.0 million dollars to maintain a soft-pegged exchange rate, official data showed, indicating a steady decline as credit picked up amid money printing.

In October the central bank bought 49.0 million dollars implementing a ‘strong side convertibility undertaking’ and only sold 1.50 million dollars to implement a ‘weak side convertibility undertaking’ to maintain the peg with US dollar.

The central bank had been keeping the rate around 185 to the US dollar, below the 182 levels at the end of 2019 in a de facto real effective exchange rate targeting exercise which had led to permanent depreciation in the past, analysts say.

In September 56 million dollars was bought and 1.25 million dollars were sold to keep the peg.
In August 121 million dollars were bought and 28 million dollars were sold.

Sri Lanka’s private credit spiked sharply in March 2020 after money printing and a so-called ‘flexible exchange rate’ episode.

In a flexible exchange rate episode, the central bank suddenly backs out of the weak side convertibility after printing money to drive credit, inducing panic among market participants and making importers take more credit and cover their bills ahead of time.

A weak side convertibility undertaking is deployed at some arbitrary level after panic is induced in a so-called disorderly market conditions or ‘DMC’ rule.

The abandonment of the weak side convertibility undertaking and the re-deployment at some unknown DMC level, is also backed by the International Monetary Fund.

Critics say the DMC combined with high inflation targets, above 2-3 percent are a key reason for IMF programs to fail and currency crises to be created within programs.

Sri Lanka’s private credit spiked sharply in March in the flexible exchange rate episode and the DMC weak side convertibility undertaking was deployed just under 200 to the US dollar.





The ‘flexible exchange rate’ episode however earned the country a credit downgrade.

Amid lockdowns, private credit contracted after April 2020, allowing the central bank to purchase dollars. But from August private credit started to expand.

A credit expansion generally hits the forex market about 6 to 8 weeks later, analysts who study the credit system closely say.

Sri Lanka’s imports have also picked up as credit recovered.

“Sri Lanka has slapped import controls in April to stop what bureaucrats and Mercantilists believe are undesirable imports,” says EN’s economic columnist Bellwether.

“But credit is fungible and it will flow to other sectors”.


Sri Lanka imports rise as credit picks up

November credit data is still not out.

But record money printing under ‘Modern Monetary Theory’ had pushed interbank rupee rates, below dollar rates and Sri Lanka’s implied forward foreign exchange rates are now negative amid financial account tightening. (Colombo/Dec22/2020)

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