ECONOMYNEXT – Sri Lanka’s central bank is on track to make quasi-fiscal losses on its dollar book as its net foreign assets declined to around 51 million US dollars in July and reserve related and other liabilities come up to its gross foreign reserves, data shows.
The reserve banking for the domestic note issue had also fizzle out to 0.97 percent by July.
The central bank’s net foreign assets fell to 10.3 billion rupees or about 51 million US dollar in July 2021 from around 4.2 billion US dollars a year earlier, amid so-called Modern Monetary Theory liquidity injections.
The central bank’s gross foreign reserves fell to 2,833.5 million US dollars in July from 4,060 million US dollars in June.
However about 1.3 billion dollars of the reserves are owed the International Monetary Fund, about 580 million dollars in swaps and also there is usually a liability to the Asian Clearing Union countries.
In the past the central bank used to report book profits when the currency was inflated (depreciated) with money printing.
However when foreign assets turn negative the central bank will begin to accumulated quasi-fiscal losses on its dollar book.
The central bank now holds 1.2 trillion rupees of Treasuries, which will bring it ‘profits’.
A central bank can also run sterilization losses on injected liquidity. If banks deposit liquidity in windows at 6.0 percent, which have been injected through bond purchases at 5.23 there is a sterilization loss.
Though such activities are clearly monetary however they will eventually eat into the capital of the bank and the Treasury will have to bail the bail it out.
“..[O]perations of a less obviously fiscal—and more obviously monetary—character, such as sterilization or open market operations, are commonly referred to as QFAs because of the large losses they can entail sooner or later affect the budget,” notes the IMF.
The remaining gross reserves will also bring in interest earnings, but the central bank will have to pay interest on IMF loans. The swaps also have premiums which usually bring income.
However swap turned negative in 2021 amid as dollar yields outpaced rupee yields amid money printing and sovereign bond yield falls amid downgrades.
An IMF special drawing rights allocation is also neutral on net foreign assets as interest earn on the holding is balance out on interest rates paid on the allocation.
If the SDR allocation is used, the central bank will have to pay interest and also run book quasi-fiscal losses.
Central bank swaps also do not increase net foreign assets.
Meanwhile the net foreign assets cover for rupee notes was less than one percent by July 2021.
Foreign assets have been declining steadily since money was printed through overnight and term reverse repo injections to target a call money rate and then bonds bought outright for output gap targeting and followed by modern monetary theory from 2020.
The central bank has raised the statutory reserve ratio effective September 02, which is also likely to widen the deficit, since the margin is fully sterilized at 6.0 percent through overnight window. The move however will also reduce sterilization losses.
Analysts and economists had urged authorities to convert the central bank to a currency board.
However now it is too late with no dollar cover for the note issue.
Central Bank quasi-fiscal activities (QFAs) are usually defined as activities should have been carried out by budgets.
Sri Lanka’s central bank has already funded a Zimbabwe style re-finance scheme for Covid loans and another such credit scheme for state enterprises has been requested.
In August policy rates were raised however bond auctions are still not functioning. Analysts have urged the central bank to get bond auctions working again.
In countries where central bank’s have run massive QFA’s and lost control of monetary policy, market or de facto dollarization has taken place.
Sri Lanka’s central bank was set up by John Exter, US Fed money doctor, in the style of several similar so-called Prebisch-Triffin central banks in Latin America.
Ecuador (David Grove), El Salvador (Henry Wallich/John Adler) are officially dollarized while other countries such as Cuba (Henry Wallich) and Venezuela have dollarized de facto.
The central bank of Phippines also set up by Exter, had to be re-capitalized after quasi-fiscal losses.