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Sri Lanka central bank makes Rs14bn hedging loss in 2018

ECONOMYNEXT – Sri Lanka’s central bank has made a 14.8 billion rupee loss on outstanding swaps which have hedged the foreign exchange risks of banks in a quasi-fiscal activity, published accounts show.

Sri Lanka’s soft-peg with the US dollar collapsed from around 152 to the US dollar to 182 to the US dollar during 2018 in the wake of two liquidity shocks generated by the central bank.

In 2018 the central bank made a 137 billion rupee profit mainly from currency depreciation and liquidity injections.

A collapse of the currency increases the rupee value of any remaining net foreign reserves.

But if there are swaps, through which forex hedging had been provided to banks or other borrowers in a quasi-fiscal activity, there is a loss.

"…[T[he Bank entered into Swap transactions with Licensed Commercial Banks (LCBs), Licensed Specialized Banks (LSBs) and Foreign Central Banks in order to maintain international stability of the Sri Lankan Rupee, to strengthen the financial system of the country and to encourage those Banks to bring foreign funds," the central bank said in accounting notes for 2018.

If the corresponding dollars had been used in currency defence, there is net loss for the central bank. In earlier years hedging deals have also brought profits.

The central bank of Philippines, set up along the lines of Sri Lanka by the same US official collapsed partly due to swaps, analysts say.

Under Governor Indrajit Coomaraswamy however large volumes of those swaps had been wound down safely, particularly in 2017, when the there was a balance of payments surplus as credit slowed and the central bank mopped up inflows.

The rupee value of currency swaps was down to 203 billion rupees by end 2018 from 374 billion rupees in 2016.





The IMF has also urged the central bank to terminate the swaps.

In July 2018 however the central bank entered into so-called Soros-style swaps to boost reserve money and helped worsen a liquidity shock, critics have said. Similar swaps had helped bring down the Bank of Thailand during the East Asian crisis, analysts have said.

In September the central bank also sterilized a maturing swap, adding to monetary instability.

There have been calls to reform the central bank and its soft-peg to minimize monetary instability and eliminate balance of payments problems so that there is free trade and capital mobility.

Sri Lanka’s economic problems started shortly after a soft-pegged exchange rate regime with a central bank which could print money to artificially control interest rates was set up.

Initially the exchange rate was held down with draconian trade and exchange controls, but after 1978, the rupee collapsed steadily with high inflation partly due to implicit real effective exchange rate targeting. (Colombo/June27/2019)

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