Sri Lanka forex reserves down to Rs7.5bn in March amid liquidity injections
ECONOMYNEXT – Sri Lanka’s forex reserves were down by 412.5 million US dollars to 7,525 million by end March 2020 from 7,938.24 million US dollars in February central bank data showed, as liquidity injections continued in to money markets.
Sri Lanka’s forex reserves are made up of the central bank’s monetary reserves which are collected by mopping up inflows (destroying liquidity) and Treasury reserves built up by borrowings.
Sri Lanka has been unable to collect significant volumes since 2015.
Analysts have identified several key deteriorations of policy in recent year, narrowing of a policy corridor which reduced protection to the peg, call-money-rate-targeting-with-excess-liquidity which lost the protection of any remaining corridor (100 bp), the purchase of Treasury bonds which allowed the central bank to manipulate rates further up the yield curve and trigger more distortions.
Central bank reserves may be compromised if they are tied to swaps (forward cross currency deals which the central bank is contracted to pay out dollars in the future, sometimes at a rate more favourable to the counterparty).
The Bank of Thailand was counterparty to speculators who got liquidity to bust the peg, data released after the East Asian crisis showed.
Sri Lanka’s central bank has injected large volumes of liquidity to the banking system, over and above the cash required.
Mercantilists had also claimed that the currency came under pressure from rupee bond sales by foreign investors not over-issue of rupees.
However rupee bond holders became an issue only in the 2008/2009 currency crisis, when the rupee was already at 110 to the US dollars down from 4.70 to the US dollar to join the Bretton-Woods system and exchange and trade controls came soon after.
Ironically before the soft-peg was set up Colombo was a regional financial centre supplying capital to countries like Malaysia under the silver-linked (Indian Rupee) currency board that operated from 1885 to 1950.
Analysts expected the rupee to come under pressure in May as credit recovered, due to unsterilized excess liquidity from April and a possible rate cut as credit demand recovered as had happened in 2018 when the rates were cut in April when the economy recovered.
Analysts had warned that rate cuts and liquidity injections may lead to downgrades and severe deterioration of the external sector.
Liquidity injections forces the peg to be defended, to stop the peg from breaking. Mopping up liquidity on the other had allows forex reserves to built up.
However rates were cut from January 30. Large liquidity injections were made from late February and then in March despite a Coronavirus crisis unsettling market participants. (Colombo/Apr10/2020)