ECONOMYNEXT – Sri Lanka’s central bank has bought 45.9 billion rupees of Treasury bills on Friday takings it total Treasury bills stock to 1330.3 billion rupees, official data shows, as foreign reserve losses continue amid non-market interest rates.
Soft-pegged central banks lose foreign reserves when liquidity is injected to maintain a rigid interest rates structure as convertibility is provided to the new domestic currency which triggers imports after cascading credit.
The peg breaks as soon as convertibility is suspended by the soft-pegged or ‘flexible exchange rate’ central bank which runs out of reserves a more money is printed.
In Sri Lanka, de facto reserve appropriations are also done against direct acquisition of Treasuries to meet external state repayments without a liquidity change (reserve pass-through) in back-to-back transactions which does not alter rupee reserve balances of banks.
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In the heavily Mercantilist nations, the exchange rate pegging (providing convertibility), rather than liquidity injections are blamed for the eventual currency collapse or suspension of convertibility.
Parliamentary approval is not sought to suspend convertibility (break the peg) and effectively default on the holders of the bank’s zero coupon paper or rupee notes.
In Sri Lanka most of the money in 2021 had been printed to enforce a series of rigid interest rates on government securities which discouraged investment in government securities and finance a budget deficit without crowding out private consumption and investment to balance the external sector.
The biggest item on the budget are state salaries, which were ratcheted up as part of ‘revenue based fiscal consolidation’ a somewhat naïve and unusually extreme ‘anti-state-austerity’ attempt to bridge a deficit by expanding the burden of the state on private sector.
Following ‘revenue based fiscal consolidation’ state spending as a share of gross domestic product went up to close to 20 percent from an earlier 17 percent. Now taxes have been cut worsening the fallout from ‘revenue based fiscal consolidation’.
Analysts say when the new rupees issued against Treasury bills are effectively cheques written by the central bank without dollars in its reserves come, which then ‘bounce’.
“A suspension of convertibility is similar to a stop payment order,” explains EN’s economic columnist Bellwether. “It makes the reserve money nonconvertible. What is called a float is a suspension of convertibility.
“But for whatever regime to work, liquidity injections have to stop or the writing of new cheques have to stop.”
The central bank last week abolished the price controls on Treasuries auctions which provides and opportunity for the private sector, which is a net saver that usually finances the deficit, to buy bonds and re-direct savings to the budget using existing money.
However it also requires interest rates to go up and find a level. The next bill auction is on Wednesday.
Analysts had warned that with reserves running out, the central bank is on track to report very high quasi-fiscal losses. (Colombo/Sept20/2021 – Update II)