ECONOMYNEXT – Sri Lanka’s commercial banks have reduced their negative foreign asset position over the past year by over 500 million US dollars since rates were hike in April 2022, official data show.
Commercial banks had a negative 732 million US dollar foreign asset (borrowed abroad and gave credit domestically) position in April 2022 which has fallen to a negative 230 million US dollars by November 2022.
At offshore banking units, NFA turned positive in May and was plus by 292.9 million US dollars by November 2022, central bank data show.
At domestic banking units, NFA is still negative by 523 million US dollars.
A pegged regime that does not print money through open market operations can make any foreign capital payment without a problem (free flow of capital) as long as money is not printed to maintain a fixed policy rate after interventions.
If there is no policy rate enforced with liquidity injections, banks have to curtail domestic credit to repay a foreign credit line or a swap automatically eliminating forex shortages.
Any foreign repayment (an outflow through the financial account) reduces domestic credit, domestic investment and imports (reduce the current account deficit), as long as interest rates are market driven.
The problem is explained by classical economists as the impossible trinity of monetary policy objectives.
Economic bureaucrats who operate soft-pegs or flexible exchange rates, or flexible inflation targeting with a reserve collecting central bank pretends that the problem does not exist, as s result countries with reserve collecting central banks run into forex shortages.
Then exchange and import controls are imposed.
Sri Lanka is set to legalize flexible inflation targeting under and IMF backed program.
Sri Lanka’s commercial banks had borrowed abroad, especially to buy Sri Lanka Development Banks in recent years as forex shortages increased under flexible inflation targeting, giving credit beyond foreign currency deposits in their books.
Banks also lent to Ceylon Petroleum Corporation as forex shortages emerged from flexible inflation targeting.
The government started to have difficulties in repaying SLDBs several months before default was declared in April 2022.
SLDBs were repaid through several methods, including offsetting against surrender requirements. Banks have also been allowed to run up net open positions to reduce the fx exposure.