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Saturday June 15th, 2024

Sri Lanka following John Law, rupee debauched in MMT: legislator

ECONOMYNEXT – Sri Lanka is treading on the path of John Law, an 18 century French Mercantilist who drove France to a monetary meltdown with an early central bank, in implementing so-called Modern Monetary Theory debauching the currency, an opposition legislator has charged.

Sri Lanka cut taxes sharply in December 2019 in a fiscal ‘stimulus’ and started printing in large quantities following several rate cuts in early 2020 in a monetary ‘stimulus’.

John Law Returns

“Look at the problems in fiscal policy. What was the benefit of cutting taxes?” opposition legislator Kabir Hashim questioned in parliament.

“Government revenues fell and prices of goods went up. Look at monetary policy. In 1700s in Britain there was a man called John Law. It is his policies we are following now, printing money and calling it MMT.”

Law fled his native Scotland to France over an incident in a duel, but had tried interest Scottish leaders in setting up a central bank and a national paper money.

Scotland had a series of free banks where a type of short term advances of printed money similar to ‘provisional advances’ found in Sri Lanka’s central bank law, called the ‘real bills doctrine’ which was in use to various degrees.

However he failed to persuade Scottish leaders including the Duke of Argyle of his scheme. Following his flight to France, Law cultivated a friendship with the Duke of Orleans, who was regent to King Louis of France.

In 1720 Law was appointed Controller General of Finance. A private bank set up by Law (Banque Générale Privée) was nationalized as Banque Royale and it bought government debt.

“He (Law) bankrupted France,” Hashim said. “The same thing is happening in Sri Lanka.”

Mississipi Stocks

Placing restrictions on free trade, Law created several companies with crony-Mercantilist monopoly powers including the Mississippi Company, driving up stock market prices with excess profits.

In Sri Lanka import restrictions are also driving up stock market profits of some so-called crony import-substitution companies, which exploit people with high prices benefiting from import duties and import controls.

However inflation soon followed and stock markets collapsed as people demanded gold in return for the paper money, in a similar way people demand dollars in return for printed money in a pegged exchange rate central bank.

Hashim said hundreds of billions of rupees had been printed in 2020.

“Where had his money gone?” he questioned. “There should be lots of money. Why is the government saying there is no money now?”

The money left country as a balance of payments deficit as the new money was redeemed for foreign reserves for trade transactions and for dollar debt repayment through the ‘convertibility undertaking’ of the peg.


Sri Lanka’s central bank buys bonds in new money printing phase

Sri Lanka sells US$76mn in August after liquidity injections

The BOP deficit started in late 2019 as the Yahapalana central bank bought bonds to target an output gap and lower interest rates artificially again ending a policy of mopping up inflows.

Excess Money Redeemed for Reserves

The BOP deficit in 2020 was 2.3 billion US dollars. In 2021 up to April the BOP deficit was over 900 million dollars.

“The rupee had been severely debauched (mus-ther barl-doo),” Hashim said. “Mahinda Rajapaksa hit the rupee over 100 to the US dollar in 2005. Gotabaya Rajapaksa hit it over 200 to the US dollar in 2020/2021.”

However the central bank in the administration in which Hashim was a cabinet minister also followed a milder version of MMT called ‘output gap targeting’, triggering currency crises.

Ironically the International Monetary Fund gave technical support to calculate a supposedly existing ‘output gap’.

Hashim’s administration also followed a more non-credible peg called the ‘flexible exchange rate’ involving vicious dual anchor conflitcs, which switched between floating and fixed rapidly, sometimes within the same day, due to refusal to convert to dollars very much smaller volumes of printed money and went sliding down.

The administration also made an attempt to institutionalize dual anchor conflicts by writing the ‘flexible exchange rate’ into the monetary law.

Printing money to target an output gap created a currency crisis in 2018 driving the rupee down from 153 to 182 to the US dollar forcing corrective policies to be implemented as the balance of payments was blown apart, in a so-called ‘stop-go’ policy. (Stop-Go policies of the political business cycle)

The central bank also jettisoned a ‘bills only policy’ trying to control long term yield curve, going beyond a short term ‘real bills doctrine’ to longer term permanent injections of money in the style of Banque Royale.

It was claimed that ‘inflation targeting’ was followed, despite operating the highly unstable pegged exchange rate called ‘flexible exchange rate’ with a foreign reserve target, which analysts warned would end in disaster.

The 2018 debacle was also significant since money was printed despite tax hikes and market pricing of oil, showing there was no fiscal dominance of monetary policy.


Sri Lanka may be heading for a triple anchor, ‘inflation targeting’ oxymoron: Bellwether

However the country does not have a floating rate to avoid a currency collapse when money is printed through open market operations.

Deteriorating Policy

After busting the rupee the central bank also controlled deposit rates, in an unprecedented double expropriation of the small man in favor of leveraged businesses and the state in another Mercantilist intervention.

The central bank also engaged in real effective exchange rate targeting resisting an appreciation of the currency in 2017 while buying up over a billion US dollars in reserves and also undoing dangerous swap deals.

Instead of letting the currency appreciate like in 2010 and 2011, the rupee was further depreciated by 3 rupees in 2017.

The then administration gave ‘central bank independence’ and allowed REER targeting, a blatantly Mercantilist strategy aimed at getting a short term trade advantage by destroying real wages of export workers.

The then-cabinet also did not objects to ‘output gap targeting’ to be implemented though no cabinet sanction had been given for such an action which went against the stability objective of the central bank.

A policy rate corridor was also narrowed from 150 to 100 basis points, and no action was taken.

MLA mandate for stability

Call money rate targeting was then started where large volumes of money was printed to target a rate below the ceiling of the corridor making nonsense of the idea of having a policy corridor in the first place which is to allow rates to go up automatically when a peg is defended.

Critics have pointed that the central bank only has a stability mandate and no growth mandate for any John Law type activity other than provisional advances for six months, and both output gap targeting and MMT violates Section 05 of the constitution of the central bank.

However even in 1950, an economist writing in The Banker magazine warned that the six-month limit was no protection as long at the CB could buy Treasuries and had many tools used in Latin America.

Sri Lanka’s central bank was one of several set up by the Fed in Latin America and Asia in the style of Argentina’s central bank.

In 2015 large volumes of money was injected initially to keep call money rates at the bottom of the corridor eventually driving the rupee from 131 to 151 to the US dollar by early 2017 in the first currency crisis in the last administration.

Analysts warned that the call money rate targeting would be a death-knell for the rupee and REER targeting would, trigger monetary instability and political unrest.

However MMT is much more dangerous.

Analysts have warned that MMT combined with swap deals could make the central bank insolvent, in addition to possible sovereign default and could trigger a monetary meltdown unless corrective action was taken to stop printing money.

History Repeats
The 2020 MMT exercise was done despite the experience of 2015 and 2018, where growth collapsed after the liquidity injections triggered currency crises.

In France, despite the experience of the John Law’s paper money, a currency called Assignat was printed after the French revolution. The assignat was printed not against Treasury bills but land seized mostly from the Church and ‘assigned’ against paper livres.

The currency soon lost value and trading restrictions and exchange controls were brought to maintain its value.


Sri Lanka tightens capital controls, outflows from forex accounts capped

In August, 1793, a law was passed punishing any person who sold assignats at less than their nominal value with imprisonment for twenty years in chains, and later a law making investments in foreign countries by Frenchmen punishable with death.

“On whom did this vast depreciation mainly fall at last?”,” questioned Andrew Dickson White in his work Fiat Money Inflation in France.

“When this currency had sunk to about one three-hundredth part of its nominal value and, after that, to nothing, in whose hands was the bulk of it?

“The answer is simple.

I shall give it in the exact words of that thoughtful historian from whom I have already quoted: “Before the end of the year 1795 the paper money was almost exclusively in the hands of the working classes, employees and men of small means, whose property was not large enough to invest in stores of goods or national lands.

“Financiers and men of large means were shrewd enough to put as much of their property as possible into objects of permanent value.

“The working classes had no such foresight or skill or means. On them finally came the great crushing weight of the loss. After the first collapse came up the cries of the starving.” (Colombo/July02/2021)

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Sri Lanka beats key IMF program targets for March 2024 amid rupee stability

ECONOMYNEXT – Sri Lanka has exceeded key quantitative targets set in an International Monetary Fund program for March 2024, based on preliminary data the Washington based agency said in a report.

The March data are not performance criteria on which reviews are conducted but are indicative targets which shows the progress of the program and are a stepping stone for a September review based on June data.

An indicative target for the primary balance (roughly overall deficit minus interest costs), was assessed at 316 billion rupees more than four times the 70 billion rupee target set in the program.

Primary balance can be a big surplus if the interest bill is high and capital expenditure is cut and is a type of crisis management tool after a central bank triggers a currency crisis by cutting rates with inflationary liquidity tools.

However, Sri Lanka’s Treasury has also kept a lid on most current spending. A state salary hike is however due after the currency collapse made life difficult for everyone.

Meanwhile more taxes have been collected from the people to finance the island’s bloated state.

A 750 billion rupees central government tax revenue floor has been exceeded to reach 837 billion rupees.

Central bank credit to government (outstanding stock) has been reduced to 2,691 billion rupees in March compared to a target of 2,800 billion rupees. In December the CB credit was calculated 2,742 billion rupees.

Net international reserves of the central bank were brought up to a negative 1,268 million US dollars exceeding the target of a negative 2,035 by almost 700 million dollars.

In order to collect foreign reserves, which is a type of appropriation of domestic savings of the people by the central bank (taking in deposits) and exporting it to the US and other countries to finance their deficits or by other agency debt in reserve currencies.

In order to collect such ‘deposits’ the central bank has to prevent them from being invested domestically.

It is achieved with deflationary policy through sell-downs of down its Treasuries holding to domestic banks or others, at a market rate, collecting interest from the government or repayments of re-finance credits, subject to any nominal changes in reserve money at a given exchange rate.

In 2024 the central bank allowed the exchange rate to appreciate, which can also reduce prices of traded goods boost real and nominal savings and make it easier to collect foreign reserves.

When domestic credit is weak it is easier to collect reserves. Reduced domestic credit and collection of reserves, including by private banks which then cannot be invested domestically, can push the external current account into surplus.

The central bank also met a 5 percent 12-month inflation target, with an achievement of 4.3 percent.

Sri Lanka’s economy grew 5.3 percent despite reserve collections, amid the stability provided by the central bank.

There were no central bank purchases of Treasuries from the primary market.

However the central bank injected overnight and term money to banks (not on a net basis) showing how easy it is for a rate-obsessed monetary authority to get around the requirement and create external instability again as soon as private credit recovered.

The central bank also allowed excess liquidity from dollar purchase to remain unsterilized for an extended period under its ad hoc pegging arrangement, getting a short term falls in rates, but triggering pressure on the rupee as a result in May and June.

It is not possible to collect reserves with a free floating exchange rate. (Colombo/June15/2024)

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Sri Lanka GDP grows 5.3-pct in first quarter of 2024 amid monetary stability

ECONOMYNEXT – Sri Lanka’s gross domestic product grew 5.3 percent in the first quarter of 2024 data from the state statistics office showed as the central bank continued to refrain from generating monetary instability.

Instead of printing money to cut rates under ‘flexible inflation targeting’ and printing money to boost growth by taking into account ‘potential output’ as permitted by its new monetary law, the central bank ran deflationary policy and also allowed the rupee to appreciate.

“The Sri Lanka economy experienced a more favorable economic condition[s] in the first quarter 2024, when compared to the first quarter in the year 2023,” the Department of Census and Statistics said.

“The high inflation had prevailed in the first quarter of year 2023, gradually reduced to a lower level by the first quarter of 2024 and this low inflation incentivized the economy by providing inputs at [a] much lower price.

The agriculture sector grew 1.1 percent in the first quarter of 2024, after also growing 1.6 percent last year.

Industry grew 11.8 percent in the first quarter, against a 24.3 percent last year.

The economy grew amid falling prices, the statistics office said in sharp contrast to the Anglophone macroeconomic claim that inflation is needed to boost growth, on which Sri Lanka has 5-7 inflation target has apparently been set.

Related Sri Lanka central bank pushing for high inflation target to boost growth

“Among ‘Industrial activities’, coinciding with the decline in input prices, the ‘Construction industry’ grew by 14.2 percent, parallel to this, the ‘Mining and quarrying’ industry too expanded by 18.3 percent during this quarter,” the Statistics Department said.

Sr Lanka’s services sector grew 2.6 percent, against a decline of 4.6 percent recorded last year.

The International Monetary Fund has also urged the central bank to give priority to stability.

Sri Lanka dropped the stability mandate in the earlier monetary law which was violated after the end of a civil war to push the country into serial currency crises especially after the International Monetary Fund gave technical assistance to calculate potential output.

Related Sri Lanka has a corrupted inflation targeting, output gap targeting not in line with monetary law: Wijewardena

Sri Lanka survived a 30-year civil war by giving priority to a stability mandate despite shortcomings in its operational framework but defaulted in peacetime amid activist monetary policy which denied monetary stability to the people. (Colombo/June12/2024)

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Sri Lanka’s NPP notes five-point crisis for economic growth sans details

Former JVP MP Sunil Handunneththi

ECONOMYNEXT — The leftist National People’s Power (NPP) has identified five crises that need resolving for Sri Lanka’s economy to progress, much of which emphasise a production economy targeting export growth though sparse on the detail on resource allocation.

NPP spokesman and former parliamentarian Sunil Handunneththi speaking at an event in Mulaitivu on Thursday June 13 said Sri Lanka is grappling with firstly, a collapse of the production economy, second, a budget deficit, third, a balance of payment crisis which has, fourthly, created a debt crisis, and finally, a resultant gap between haves and have-nots.

“We must first understand the crisis. We reocgnise five main crises that have the same impact irrespective of differences between the north and south.

“The first is the collapse of the production economy. We can see this historically. Agriculture that used to be some 30 percent of gross domestic product (GDP) has now fallen to 8 percent. Essential food is imported. We cannot produce the rice needed for the small population here. Things that can be made here are also imported.

“Second is the income crisis. For the people, their expenses are twice their income. The budget deficit is two or three-fold every day. Banks cannot give loans to businesses and industries because the government takes funds to address the budget deficit. The government takes most of the people’s savings for this,” he said.

The balance of payment crisis Sri Lanka is facing the third crisis, according to Handunneththi, which has triggered a debt crisis, in turn leading to a crisis of income disparity among the people.

“Third is the balance of payments crisis. Imports are two or three fold export income. The government has to take 11 to 12 billion US dollars in loans from foreign countries. When GDP is 80 billion US dollars, debt has gone over 100.”

“All this creates a massive gap between haves and have-nots. Without finding solutions to these crisis, there is no point distributing goods,” he said.

Handunnethi’s remarks appear to be departure from the NPP’s anti-corruption rhetoric which had centred its economic development policy agenda primarily on fighting corruption.

‘Fighting corruption’ and ‘recovering stolen assets’ have been popular slogans since the Aragalaya protests in Sri Lanka and the NPP has made it its central theme in its bid for power. The leftist outfit had also adopted a position that’s cautiously critical of the International Monetary Fund (IMF) and the reforms the international lender has prescribed for Sri Lanka in exchange for a 2.9 billion-dollar bailout.

However, NPP leadership had recently acknowledged the need to continue the IMF programme since the agreement has already been signed.

The Marxist-Leninist Janatha Vimukthi Peramuna, which controls the NPP, though it was never in government barring a brief stint in an Sri Lanka Freedom Party (SLFP)-led coalition in the early 2000s, has been instrumental in driving popular support against privatisation.

Three key policy pillars articulated by the JVP from 2001-2004 and embraced by mainstream politician Mahinda Rajapaksa’s administration in 2005 onward have been highlighted by experts.

From 2005, Sri Lanka halted privatisation, started recruiting tens of thousands of unemployed graduates into the public service every year with lifetime pensions, expanding an already bloated public sector and denying any benefit of a peace dividend to the country.

Sri Lanka also abandoned a price formula for fuel that had helped keep the rupee stable and inflation low from 2001 to 2003 even as global commodity prices went up from the ‘mother of all liquidity bubbles’ fired by the Federal Reserve from 2001.

From 2001 to 2003, state workers fell from 1.164 million to 1.043 million. By 2020, the public sector cadre has grown to 1.58 million with another batch of 53,000 unemployed graduates being paid tax money. (Colombo/Jun14/2024)

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