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Monday March 4th, 2024

Sri Lanka central bank ‘unprints’ money

ECONOMYNEXT – Sri Lanka’s central bank has sold down its Treasury bills stock for the second week, taking its holdings of Treasury bills purchased to trigger monetary instability in March and April to 296 billion rupees on Friday from 303 billion rupees a day earlier, official data show.

The week earlier the central bank also sold down its Treasury bill stock taking the stock down by about 8 billion rupees to from 311 billion rupees.

Over the past two weeks the central bank had sold down about 14 billion rupees of Treasury bills and withdrawing liquidity from money markets potentially saving about 75 million US dollars in forex reserves that would otherwise have been lost.

A soft-pegged central bank can withdraw excess liquidity either by selling domestic securities (Treasuries or its own sterilization securities) or defending the peg with dollar reserves (an unsterilized dollar sale) to reduce forex shortages.

When domestic credit is strong, a soft-pegged central bank will however print more money to target a short term rate after selling dollars (sterilized forex sales) re-inflating reserve money to the previous level, resisting correction in the credit system.

Data showed that in the current bout of monetary instability the central bank has sold about 1.3 billion US dollars unsterilized mopping up part of the 400 billion excess liquidity injected to inflate reserve money, since February.

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In 2018 Sri Lanka’s central bank triggered monetary instability by injecting liquidity to target a call money rate below the ceiling policy rate, without any fiscal dominance or political pressure, analysts have showed.

Analysts also warned in November and December 2019 monetary instability as well as credit downgrades was likely as the credit system recovered unless there was monetary reform.

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Last week the central bank conducted the Treasuries auction before a policy corridor was cut by 100 basis points to 4.50 percent (floor) and 5.50 percent (ceiling).

Before the rate cut amid excess liquidity injected earlier the overnight interbank rate was already touching 5.50 percent. After the cut the overnight rate again fell to 4.50 percent.

In May the central bank had bought 61.5 million dollars in interbank forex markets amid private credit in April and lockdown which hit consumption as well as import controls, and in June 69 million dollars were bought and 9.25 million dollars were sold.

In May private credit picked up from April lows data showed.

Before the rate cut the central bank had allowed some term reverse repo deals without rolling them over, withdrawing more liquidity and potentially saving forex reserves.

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An overnight rate hitting the floor of the corridor generally points to weak domestic credit, though now large amounts of the excess liquidity had come from domestic asset purchases (printing money) to pay state salaries and meet expenses as well as cuts in statutory reserve ratios.

Excess liquidity hit a high of 224 billion rupees on June 17 with a reserve ratio cut. Reserve ratio cuts themselves structurally lower interest rates by reducing inefficiencies in the banking system.

Excess liquidity which fell to 160 billion rupees on Thursday rose to 166 billion rupees on Friday despite the bill sell-down.

The central bank is also re-financing loans from commercial banks creating more money, but by selling down the Treasury bills stock it can neutralize part of the negative effects and reserve losses.

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Liquidity had also been created with dollar rupee swaps with commercial banks.

Classical economic analysts point out that the Bank of England during the ERM crisis and the East Asian central banks like the Bank of Thailand during the crisis also gave ammunition (domestic currency) to speculators through such deals.

In general when a auctions of domestic government bonds (or roll-overs of sterilization securities) fail and the central bank purchase part of all of the securities to inflate the reserve money supply, a country will run into forex shortages and could also default on foreign debt.

Transfer Problem

Classical economists have tried to explain to Mercantilists and neo-mercantilists in the Keynesian tradition in particular that balance of payments troubles comes from inflating reserve money and credit and not debt repayment or imports.

The mis-understanding is generally referred to as the ‘transfer problem‘.

Until it is understood, balance of payments problems as well as import controls, import substitution, price controls and rent seeking will persist in a country as policies are directed to ‘save foreign exchange’ instead of stopping the injections of domestic currency.

“The truth is that the maintenance of monetary stability and of a sound currency system has nothing whatever to do with the balance of payments or of trade,” explained Austrian economist Ludwig von Mises, who tried in vain to show that John Maynard Keynes was wrong in the so-called ‘transfer problem’ in relation to German war reparations.

“If a country neither issues additional quantities of paper money nor expands credit, it will not have any monetary troubles,”

“An excess of exports is not a prerequisite for the payment of reparations. The causation, rather, is the other way round. The fact that a nation makes such payments has the tendency to create such an excess of exports.

“There is no such thing as a ‘transfer’ problem. If the German Government collects the amount needed for the payments (in Reichmarks) by taxing its citizens, every German taxpayer must correspondingly reduce his consumption either of German or of imported products.

“Thus collecting at home the amount of Reichmarks required for the payment automatically provides the quantity of foreign exchange needed for the transfer.”

While the pre-war Weimar Republic collapsed with monetary instability, the Federal Republic of Germany which operated on Austrian classical principles (Ordoliberal), started with central bank reform and repaid all pre-war and post war debt and also paid reparations including to Israel which did not exist before the war.

“Stability may not be everything,” one time West German Economic Minister Karl Schiller said. “But without stability everything is nothing.” (Colombo/July13/2020)

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Sri Lanka rupee opens at 308.20/50 to the US dollar

Sri Lanka stocks reversed its falling trend and gained for the first time in six sessions on Tuesday closed stronger on Tuesday (21).

ECONOMYNEXT – Sri Lanka’s rupee opened at 308.20/50 to the US dollar Monday, from 308.80/90 on Friday, dealers said.

Bond yields were broadly steady.

A bond maturing on 01.08.2026 was quoted stable at 10.90/11.00 percent.

A bond maturing on 15.09.2027 was quoted at 11.90/12.00 percent from 11.90/12.05 percent.

A bond maturing on 01.07.2028 was quoted at 12.20/30 percent from 12.15/35 percent.

The Colombo Stock Exchange opened up; The All Share was up 0.60 percent at 10,755, and the S&P SL20 was up 1.24 percent at 3,077. (Colombo/Mar4/2024)

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Sri Lanka central bank swaps top $3.2bn by December

ECONOMYNEXT – Sri Lanka’s central bank borrowed US dollars from various counterparties through swap transactions, which had topped 3.2 billion US dollars by December 2024, official data show.

The net short position, including swaps disclosed by the central bank, grew by over almost 1.28 billion US dollars from December 2022 to 3,280 million dollars.

The gross position grew from 2,263 million dollars to 3,280 million US dollars over the year.

The central bank supported some state banks with dollars to cover their dollar exposures, which had since been paid back.

By December reported gross reserves of the central bank was 4,491 million US dollars, against swaps of 3,280 billion US dollars.

Swaps of around 1500 related to the People Bank of China.

Swaps allow a central bank to increase gross reserves, without raising domestic interest rates.

Swaps with domestic counterparties lead to liquidity being injected into money markets, which can be mopped if domestic credit growth is moderate.

At the moment many private banks have large dollar positions invested outside the country, which cannot be used for transactions domestically because of a money monopoly given to macro-economists. (Sri Lanka repays debt or collects reserves of U$5bn via banking system since rate correction)

However unwinding swaps after private credit has picked, or engaging in swaps after private credit has picked up, may lead to money being injected to maintain the policy rate, leading to excess credit by banks and balance of payments deficits and or currency collapses, analysts say.

Central bank swaps in the third quarter of 2018 led to a collapse of the currency under the ‘exchange rate as the first line of defence’ policy peddled to Sri Lanka, critics have said earlier.

Domestic currency proceeds of swaps were the primary ammunition to bust East Asian currencies in 1997-98.

Any depreciation after the swap proceeds have been used for imports (effectively mis-targeting rates) a central bank will run a forex loss.

The PBOC however had put a rule, preventing the use of the swap after gross reserves fell below 3 – months of imports, preventing Sri Lanka from getting into further trouble through the use of official reserves for private imports.

Sri Lanka’s central bank also used borrowings from the Reserve Bank of India, via the Asian Clearing Union to run BOP deficits.

Losses from exposed dollar positions of central banks which have gained ‘independence’ from fiscal rules and parliaments and engaged in macro-economic policy, including the Fed, have led to taxpayers bearing the losses in the end.

Swaps were invented by the Fed in the early 1960s, as it deployed macro-economic policy (printed money for growth) threatening its gold reserves and the Bretton Woods system.

Sri Lanka has other borrowings also, including from the IMF, which has made net foreign assets of the central bank negative. (Colombo/Mar05/2024)

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Sri Lanka loses MICE tourists to Thailand on minimum room rates

ECONOMYNEXT – Sri Lanka has lost Meetings, Incentive Travel and Exhibition travelers to competitors in East Asia and India due to minimum room rates as higher standard rooms were available in other countries at lower prices, industry officials said.

President of the Sri Lanka Association of Inbound Tourist (SLAITO) Nishad Wijetunga said they the industry managed to retain a majority of booking made before the minimum room rates were imposed by the state last year.

“However, there were MICE groups that were supposed to come and cancelled Sri Lanka and went to places like Thailand and other parts of India and we lost,” Wijetunga told EconomyNext.

“We know that large groups of MICE (tourists) are affected.”

India is a key source of MICE tourists to Sri Lanka.

Sri Lanka’s businesses have got used to protectionism and try to push up prices with import taxes to extract more money from customers using the coercive power of the state, with tiles and steel being among the most prominent examples.

RELATED: Stand-alone hotels unviable in Sri Lanka due to high construction, capital costs

High priced tiles and steel in turn makes hotels expensive to build and make the leisure industry less competitive, analysts say.

However, in tourism, unlike in building materials customers are not trapped within the country and are free to move to other markets.

Managing Director of CEC Events and Travels, Imran Hassan, said the industry lost groups to East Asia due to minimum room rate.

In one instance, an operator was in discussions to get a group of 900 passengers.

“And that moved out to Thailand,” Hassan said. “Like that, there are many instances that the minimum room rate was not conducive.”

Thailand in 2023 attracted 28.04 million tourists.

A group that used to come to Sri Lanka annually used to take 40 to 50 five-star hotel rooms. This time Sri Lanka competed by offering lower standard.

“This year, they’re only giving 10 rooms to the five-star hotels,” Hassan explained. “They are staying in smaller hotels because they can’t afford it because it has become so expensive.”

“But overall, we are working with the authorities to correct it.

“We don’t mind demand and supply situation taking the rates up as in the Maldives. But what we are saying is keep an open market.”

RELATED : Sri Lanka should say good bye to minimum room rates: President

President Ranil Wickremesinghe has said Sri Lanka cannot progress with protectionism and the country has to learn to face competition. (Colombo/Mar04/2024)

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