An Echelon Media Company
Monday June 24th, 2024

Sri Lanka forex reserves down to US$2.5bn in September

ECONOMYNEXT – Sri Lanka’s gross official reserves fell to 2,581.3 billion US dollars in September 2021, from 3,543.5 billion in August, official data showed, amid continued liquidity injections.

Sri Lanka’s gross forex reserves were 7.05 billion US dollars in July 2019 when inflationary policy (liquidity injections began) and the central bank started to lose its ability to collect forex reserves.

Policy deteriorated dramatically from around February 2020 as Treasury bill yields started to rise and taxes were cut in December 2019.

Price controls on Treasury bill were place in April 2021, and money was printed outside of auctions.

Sri Lanka was hit by a 2.3 billion US dollar balance of payments deficit in 2020 and 2.7 billion US dollars by July 2021, not counting the latest reserve losses.

Sri Lanka has lifted price controls on Treasuries auctions. Though volumes are smaller money is still being printed. (Colombo/Oct09/2021)

Leave a Comment

Your email address will not be published. Required fields are marked *

Leave a Comment

Leave a Comment

Cancel reply

Your email address will not be published. Required fields are marked *

Support for central bank swaps is symptomatic of Sri Lanka’s IMF return tickets

By Bellwether

ECONOMYNEXT – Sri Lanka’s central bank has been playing with swaps for some time and the agency’s 778 billion rupee forex loss in 2022 was directly related to swaps and other borrowings, which allows it to maintain an artificial policy rate.

Central bank swaps along with other doctrines like portfolio balance channels, are the foundation of modern age-of-inflation forex crises, default, outmigration and sudden soaring poverty.

As part of steps to prevent the next sovereign default by macro-economic policy, outlawing forex swaps will be a key measure that legislators can take.

The Nick Leeson style losses came not only from swaps but also IMF borrowings taken during an earlier flexible inflation targeting crisis and borrowings from India through the Asian Clearing Union, which have since been converted to a term facility.

A central bank is supposed to have foreign reserves, but with the invention of the policy rate, modern central banks engage in ‘macroeconomic policy’ or try to boost growth through money printing to suppress the policy rate and run out of reserves.

At least before swaps, macroeconomists were forced to allow market rates to go up to stop the currency from depreciating further after a central bank ran out of reserves.

But after the invention of the swaps by the Federal Reserve when it started aggressive macroeconomic policy in the 1960s, a modern central bank can continue to print money by sterilizing non-existent reserves and promote investment and imports essentially re-financing private sector activity.

The People’s Bank of China, bless its communist heart, at least stopped the macroeconomists in Sri Lanka from busting the proceeds after gross foreign reserves fell below three months of imports.

Otherwise, the central bank would have used the swap, printed more money to suppress rates, private imports would have gone up some more and instability would have continued and people would have suffered more, like they did due to the misguided ACU loans India gave.

The entire doctrine of ‘reserve adequacy metric’ of the IMF’s statistics is completely flawed as central bank reserves cannot be used to make private sector imports, which is enabled by liquidity injections made to sterilize outflows.

Any use of central bank reserves must result in a rise in market rates and a fall in rupee reserves in banks (a real outflow of funds) to maintain external stability.

Where and when did this perfidy start?

The Federal Reserve was the culprit behind the swaps which allowed macro-economists to suppress rates on borrowed money.

The Fed during the Bretton had a lot of gold reserves, but it did not have a lot of foreign exchange, unlike other central banks.

When the fed printed money for ‘macroeconomic policy’ (boost employment) and continued artificially low interest rates it had to get foreign exchange from somewhere to redeem the dollars that boomeranged on itself. The Fed then went shopping in Europe, from the Bank of International Settlement, France and Germany.

The initial ad hoc swaps started with Swin National Bank in 1960.

Charles Coombs, head of the foreign exchange desk at the New York Fed was the perpetrator who built swap facilities with counterparty central banks on a standing basis and eventually helped in the collapse of the Bretton Woods.

Swaps also helped worsen currency crisis in Sri Lanka and also does in countries by giving another tool to policy rate-obsessed macroeconomists to delay rate corrections and end up with a 700 billion rupee loss in 2022.

When Fed printed money in excess of its gold holdings it was obliged to exchange them for gold (as were free banks in the old days through the clearing system) under the Bretton Woods agreement. To prevent the dollar boomeranging on itself, the Fed hit upon the idea of the swaps.

The fx taken from the swaps could be used to buy back the excess dollars from Germany or France or Belgium or whatever bank that did not print money.

Governor Brunet of Banque de France cottoned onto the trick and reportedly Bank of England the “thought that the American idea of organizing swap facilities around Europe for large sums indefinite
in time was wrong in principle” because it allowed the United States to avoid going to the IMF to resolve “deep seated difficulties” with the dollar.

The ‘deep seated’ difficulty was of course the bureaucratic policy rate which had done so much harm to Sri Lanka in the recent past.

France had greater monetary knowledge unlike the Anglophone macro-economists with the French Franc recently being fixed by Jacque Reuff into the New France, who had argued with Keynes as far back as the 1920s on current account deficits, and failed to convince him.

France was right since the dollar and the Bretton Woods eventually collapsed against gold like the rupee collapsed against the dollar in 2022.

Swaps were wrong in principle in 1960s and they are wrong in principle now.

Assuming Risk.

One of the reasons that European banks agreed to swaps was that it acted as a forex hedge. When the Fed got Deutsche Marks and exchanged them for excess US dollars instead of giving gold, the Deutsche Bank was left with exactly the same volume of dollars as before.

However, this was under the swap and any dollar devaluation (against gold) will not affect the more prudent French, Swiss or German counterparty central bank.

The Fed eventually browbeat Deutsche Bank into accepting part of the forex loss.

In 2022 when the rupee collapsed steeply Sri Lanka’s central bank made a 720 billion rupee loss on its forex operations and it was deeply in debt.

Fast forward to 2024.

What did the IMF say in support of the swaps?

This is what an IMF official told reporters in Colombo in response to a question about the central bank’s predilection for swaps.

“Rebuilding reserves is a very important component of the IMF supported programs.“One, is what we call organic purchases by the central bank in the foreign exchange market. The other one is rebuilding reserves for engaging with swaps. This can either be swaps with domestic banks, but also swaps with other central banks. The latter is a very important part of both global and regional financial safety nets.”

To be fair to the lady, Fed swaps of recent origin, including during the collapse of the housing bubble it fired, were aimed at giving dollars to other central banks as markets froze and everyone held on to cash of all kinds.

But what the Sri Lanka’s central bank did and is doing by engaging is buy/sell swaps are the 1960s style transactions, assuming enormous forex risks which eventually end up as losses like in 2022 when the currency eventually collapse from the impact of reverse repo injections or standing facilities.

Swaps with domestic banks simply allows them to convert dollar deposits (or foreign credit lines), lend them as rupee loans and the central bank will end up holding the baby when the ‘flexible exchange rate’ rears its ugly head.

What can be done?

From the foregoing it can be seen that swaps are deadly in multiple ways.

One: Central bank swaps allow macroeconomists in Sri Lanka to cut rates through open market operations and liquidity facilities and keep them down, making the eventual crisis worse.

Two: It creates a forex risk and losses to the central bank and the people since it is a state agency

Three: It creates a moral hazard for private banks as it allows them to dump the forex risk on the central bank and lend in rupees to customers or the government.

Four: In the language that modern inflationist macro-economists understand – or should understand – swaps are a threat to the credibility to its monetary policy.

As banks are sitting on large dollar balances at the moment, the temptation for Sri Lanka’s central bank must be irresistible to either swap them or borrow them and show dollars as ‘reserves’ to all and sundry and the IMF. And that has happened to some degree already.

Sri Lanka’s politicians can move and amendment to the central bank’s new inflationist and output targeting monetary law to ban forex swaps, as part of measures to prevent a second default.

Or legislators can draw up an outside law like the classicals did with the Bank Charter Act of the UK, and impose restrictions on the central bank through a second law notwithstanding its inflationist output targeting IMF-backed monetary law.

That will make it less easy for macro-economists to drive the country into a default in the future.

Once a country has defaulted, others tend to follow swiftly unless the centra bank is restrained through tight laws on its ability to mis-target rates.

Through swaps, a central bank can mis-target rates without buying Treasury bills. In fact the central bank can print money and destabilize the country without contravening the ceiling on domestic assets in the IMF program, just like the Fed did in the 1960s as it went about busting the Bretton Woods.

Argentina’s central bank also ended up with negative foreign assets due to its dollar borrowings. It also issued dollar securities.

Same Story – All geographies, all centuries

For several years this columnist had warned that swaps would result in enormous losses for the central bank when the currency collapsed.

Though examples abound, the IMF dependent central banks continue to use swaps and get into trouble again and again.

The Central bank of the Philippines had to be recapitalized.

The Bank of Thailand got dollars from speculators and hit its own goal in .

So did the Bank of England in the ERM crisis.

More recently Lebanon’s central bank borrowed dollars (took deposits) and eventually collapsed itself.

All this happens due to the policy rate of course. The swaps simply allow artificially low rates to be continued until the swap proceeds are lost.

Sri Lanka also has a history of this type of forex risk going back to a note issue bank before the current central bank.

The Eastern and Oriental Bank, one of two note issue (Chartered) banks that issued rupees in Ceylon closed its silver door in 1884 just like the Fed closed its ‘gold window’ and floated in 1971.

The Oriental Bank rupee collapsed 50 percent overnight but the Madras Bank’s rupee held according to surviving accounts of what happened in 1884.

The problem with the Oriental Bank was the same as Sri Lanka’s central bank.

Modern Saltwater/Cambridge central bank borrows dollars, sells them in the forex market, and then prints large volumes of money to sterilize the intervention by repurchasing Treasury bills from banks, worsening the credit cycle, leading to an eventual collapse of the currency.

The Eastern and Oriental Bank borrowed in Sterling and loaned in Silver. The rupee was Silver backed or silver denominated.

In fact, researchers who went into to 19th century ledgers of the Bank of England found that Oriental Bank was a top borrower at its sterling lending window.

That is why this column advised that removing counterparty limits for borrowing through the standing facility or reverse repo auctions was a mistake.

The imposition of the counterparty limit was a key prudential move by the current management of the central bank.

The Oriental Bank closed its doors not only due to a parity problem between Silver and Gold.

It is unfortunate the in almost 150 years we have learned absolutely nothing.

Plus ça change, plus c’est la même chose

The Eastern and Oriental Bank did not just collapse due to exchange risk, but also because of its clients, the plantation companies were hit by falling prices (as a commodity bubble deflated) and could not repay loans.

The central bank which used Sri Lanka Government paper as collateral to print money into the banking system also ended up with ‘bad loan’.

The restructure of Sri Lanka government debt had left it with hefty losses.

It must be noted that except when foreign debt is repaid with a reserve appropriation, or some deficit is being monetized through provisional advances (which was supposed to conform to the bills only policy), most of the money printed by a central bank targeting the potential output gap or policy rate has nothing to do with the government.

Government securities already in the balance sheets of commercial banks (from previous deficits) are taken to the central bank to conduct overnight term or outright reverse repo injections.

Before the Fed, central banks did not discount government paper but discounted actual trade bills (banker’s acceptances) from various fairly good companies.

The BoE researchers found that in the past, when some of the bill brokers or banks went down, the Bank of England did not actually have much losses, as the paper it took was from strong companies.

Violating bills only Policy

Either way the large mark-to-market losses of Sri Lanka’s central bank is from violating another classical central banking principle, the bills only policy.

This prudential practice was also violated in Sri Lanka in the general deterioration of policy after the end of the war, eventually ending in sovereign default.

Violating the bills only policy which was seen during the Yahapalana regime which was ousted amid currency collapses and low growth from stabilization program, allows inflationists to mis-target rates deeply into the yield curve, create forex shortages and bust the rupee.

In defence of the central bank it must be said that it took a hit on its balance sheet in 2023, so as to protect the government securities market and the move has helped bring down rates faster.

There are banking practices that must be observed in running banks.

There are even more stringent prudent rules to be observed when running a note-issue bank or a bank that can create its own reserve money or circulating medium as the classical greats used to say.

IMF has weak knowledge of operational frameworks of note-issue banks, in keeping with general saltwater doctrine, that is why its patient keep going back with increasingly worse symptoms and diseases.

The doctrine of the ‘portfolio-balance channel’ is laughable at best.

If the central bank is mis-used to target potential output, or if the domestic 5-7 inflation anchor rears its ugly head, a second default is not too far away.

A peaceful country, which overcame a civil war, was driven to a default with flexible inflation targeting/potential output targeting, the latest spurious monetary doctrine of the Saltwater/Cambridge inflationists.

Sovereign defaults hit the world like a Coronavirus pandemic after the IMF’s Second Amendment to its articles in 1978 led to severe monetary instability as the restraint from external anchoring was taken away from reserve collecting central banks.

Nothing of the ideology has changed, as can be seen with IMF endorsement of central bank swaps. That is why IMF dependent keep going back to the agency, again and again and sovereign default within 10 years of getting market access.

If legislators and the public want to end a second sovereign default, outlawing swaps should be a key rule in a law that should be brought to restrain the central bank or revise the current law into a true central bank constitution and not a law that gives it discretion to create 5 percent inflation and run exchange rate policy on top.

Continue Reading

Sri Lanka central bank appoints two Deputy Governors

ECONOMYNEXT – Sri Lanka’s central bank said Assistant Governors A A M Thassim and J P R Karunaratne were promoted to the post of Deputy Governor.

The full statement is reproduced below:

APPOINTMENT OF NEW DEPUTY GOVERNORS OF THE CENTRAL BANK OF SRI LANKA

In terms of the provisions in the Central Bank of Sri Lanka Act, No. 16 of 2023, Hon. Minister of Finance, as recommended by the Governing Board, has appointed Mr. A A M Thassim, Assistant Governor and Secretary to the Governing Board, and Mr. J P R Karunaratne, Assistant Governor, as Deputy Governors of the Central Bank of Sri Lanka with effect from 20.06.2024 and 24.06.2024, respectively.

Mr. A A M Thassim

Mr. A.A.M. Thassim has over 31 years of service at Central Bank of Sri Lanka (CBSL) in different capacities in the areas of Supervision and Regulation of Banking Institutions, International Operations, Communication, Payments and Settlements, Employees Provident Fund, Finance, Risk Management, Deposit Insurance, Security Services and Information Technology.

He has served as the Director of Bank Supervision (DBS), Director of International Operation (DIO) and Director of Communications (DCM) and has contributed towards strengthening the legal framework, governance, implementation the Basel 3 international guidelines for capital and liquidity and adoption of International Financial Reporting Standards (IFRS) 9 to the banking sector, thereby strengthening the resilience of the Financial Sector.

Further, as the DIO, Mr. Thassim was responsible for the investments and management of foreign reserves of the country and exchange rate management. Mr. Thassim has also gained experience and knowledge in the field of payment systems and was involved in the implementation of the Cheque Imaging and Truncation System. In addition, he has also served on several high-level internal committees including in the areas of monetary policy, financial system stability and international reserves.

Prior to the appointment as the Deputy Governor, Mr. Thassim held the position of Assistant Governor and was in charge of several key departments including the Bank Supervision Department. He also served as the Secretary to the Governing Board, Monetary Policy Board, Audit Committee, Board Risk Oversight Committee, Ethics Committee and Financial Sector Crisis Management Committee.

At present, Mr. Thassim is a board member of the Sri Lanka Export Credit Insurance Corporation and the Vice Chairman of the Institute of Bankers of Sri Lanka (IBSL). Further, he has also served as a board member of the Credit Information Bureau of Sri Lanka and LankaClear (Pvt) Ltd.,

Mr. Thassim is an Associate member of the Chartered Institute of Management Accountants (ACMA) United Kingdom and possesses a Masters in Business Administration (MBA) from the Postgraduate Institute of Management (PIM), University of Sri Jayewardenepura (USJ). He has also completed a programme on Gold Reserves Management from Hass School of Business, University of California, Berkeley, USA.

He is also an Alumni of Harvard University, USA having successfully completed the executive programme on Leaders in Development conducted by the John F. Kennedy School of Government.

Mr. J P R Karunaratne

Mr. J P R Karunaratne has over 33 years of service at the Central Bank of Sri Lanka in different capacities in the areas of supervision and regulation of Banks and Non-Bank financial institutions, Currency management, public debt, Secretariat, Finance, policy review and monitoring. He has served as the Director of Supervision of Non-Bank Financial Institutions (DSNBFI) and the Superintendent of Currency (SC) and has contributed towards strengthening the legal and regulatory framework in the Non-Bank Financial Institutions sector and has played a prominent role in the consolidation of the Non-Bank Financial Institutions sector. Prior to the appointment as a Deputy Governor, Mr. J P R Karunaratne held the position of Assistant Governor and was in-charge of the Department of Supervision of Non-Bank Financial Institutions, Finance Department and the Facilities Management Department.

As an Assistant Governor Mr. Karunaratne has previously overseen several other departments namely, Macroprudential Surveillance, Resolution and Enforcement, Foreign Exchange, Currency, Regional Development, Legal and Compliance, Risk Management, Center for Banking Studies, Security Services and Staff Services Management.

He has also served as the Secretary to the Monetary Board, Secretary to the Board Risk Oversight Committee, Monetary Board Advisory Audit Committee and the Ethics Committee. Further, He was on release to the Ministry of Defence, where he served as a Financial Advisor. He was also appointed as the Chief Operating Officer for the Secretariat of Committee of Chartered Accountants appointed by the Supreme Court in 2009.

He has served as the Chairman of the Sri Lanka Accounting and Auditing Standards Monitoring Board and has been a Council Member of the Certified Management Accountants (CMA) of Sri Lanka. Mr. Karunaratne was awarded the CMA Sri Lanka Business Excellence Award at the CMA Sri Lanka National Management Accounting Conference 2023 in recognition of his service to the profession. He has also received “Long Service Award” of the IBSL in 2019 in recognition of his long career and contribution as a resource person at IBSL.

He was the Project Team Leader of the South East Asian Central Banks (SEACEN) Malaysia, research project on “Implementation of Basel III Challenges and Opportunities in SEACEN Countries” and SEACEN published the research in 2013. He serves as a member of several internal and external committees at present.

Mr. Karunaratne holds a Master of Commerce Degree in Finance from the University of New South Wales, Australia and a Postgraduate Diploma in Applied Statistics and a Bachelor of Science (Physical Science) Degree with a First class from the University of Colombo. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA), UK and a Chartered Global Management Accountant (CGMA). Further, he is an Associate Member of the CMA Sri Lanka.

Continue Reading

Sri Lanka opposition questions claims that IMF housing tax is only for kulaks

ECONOMYNEXT – Sri Lanka’s opposition has questioned claims made by government spokesmen that a tax on housing proposed in an International Monetary Fund deal is only limited to rich people but if as promised by President one house is exempt, it is welcome, legislator Harsha de Silva said.

Sri Lanka President Ranil Wickremesinghe made a promise in parliament that the first house of a citizen will be excluded from the property tax.

Related Sri Lanka to exempt one house from imputed rent wealth tax: President

But opposition legislator Harsha de Silva pointed out that the IMF program documents clearly says taxes will be levied on owner occupied houses on ‘imputed taxes’, not second houses.

Under current inland revenue laws, actual rent income from a second house is already captured as part of taxable income.

The IMF document mentions a threshold value from which taxes will be exempt but not that a whole owner-occupied primary residence will be exempt.

“The tax is imposed on the income of individuals (rather than real property itself) and thus raises central government revenue in accordance with the constitution,” IMF staff said in their report.

“A similar tax was previously included in the Inland Revenue Act. No. 10 of 2006.

“Under this regime, primary residences were exempt and the assessed values for rating purposes were used to determine the base.

“Given the broad exemption and the use of outdated and downward biased annual values, the tax generated hardly any revenue.”

Meanwhile Sri Lanka has promised to impose the housing tax from April 01, 2025.

“…[W]e will introduce an imputed rental income tax on owner-occupied and vacant residential properties before the beginning of the tax year on April 1st, 2025,” the memorandum of economic policies agreed with the IMF said.

“An exemption threshold and a graduated tax rate schedule would make this tax highly progressive.

“The full revenue yield from this tax is estimated at 0.4 percent and would materialize in 2026 (with a partial yield of 0.15 percent in 2025).

“This yield would still fall short by 1 percent of GDP relative to the expected yield of 1.2 percent of GDP from the property tax envisaged for 2025 onwards.”

Presidential Undertaking

“Whatever the President said the IMF agreement says owner occupied house,” De Silva told in parliament.

“It is not the second house that is mentioned in the agreement.

“But there is one thing. I am happy as Samagi Jana Balawegaya, that we have been able to save the middle class in society from a massive tax that was to be imposed.”

In Sri Lanka there is a belief that the most productive citizens are fair game for excessive or expropriationary taxation, just like kulaks were targeted in the Soviet Union for actual expropriation, critics say.

Wealth taxes have had disastrous effects on some US cities like Baltimore, leading to falling populations and dilapidated houses.

Sri Lanka is currently facing a brain drain due to high income tax after on top of depreciation from severe monetary debasement from a flexible exchange rate, which is neither a hard peg nor a clean float.

Sri Lanka has imposed a wide range of taxes on the people to maintain a bloated state, after inflationists engaged in extreme macro-economic policy (tax and rate cuts) glorified in Saltwater-Cambridge doctrine to boost growth, throwing classical economic principles and monetary stability to the winds and driving the country into external default.

The IMF itself gave technical assistance the central bank to calculate potential output inviting the agency to cut rates to close the perceived econometric ‘output gap’.

In the run up to the default, rate cuts triggered multiple external crises, leading to output shocks as stabilization programs were implemented.

Macro-economic Policy

Macro-economic policy as known now was devised by Cambridge academic J M Keynes in the wake of the Great Depression triggered by the Federal Reserve after it invented open market operations and policy rates in the 1920s and also popularized by Harvard academic Alvin Hansen among others.

Macro-economic policy started to de-stabilize countries in peacetime in the interwar years and after World War II it led to the collapse of the Bretton Woods system.

The Great Depression was also a peacetime collapse of what was later known as the roaring 20s’ monetary bubble.

“They have blithely ignored the warnings of economists,” classical economist Ludwig von Mises wrote of European nations which got into trouble from rate cuts and Keynesian stimulus, which brought currency depreciation and protectionism in its wake from the 1930s.

“They have erected trade barriers, they have fostered credit expansion and an easy money policy, they have taken recourse to price control, to minimum wage rates, and to subsidies.

“They have transformed taxation into confiscation and expropriation; they have proclaimed heedless spending as the best method to increase wealth and welfare.

“But when the inevitable consequences of such policies, long before predicted by the economists, became more and more obvious, public opinion did not place the blame on these cherished policies…”

Who….?

In Sri Lanka however there is some understanding of the role played by macro-economists in the most recent crisis.

There are rumblings of unhappiness about ‘central bank independence’ given to an agency to create 5 to 7 percent inflation and currency debasement under a flexible exchange rate and its constitutional status relating to parliamentary control of public finances.

Sri Lanka’s central bank’s current flexible inflation targeting (inflation targeting without a floating rate) regime as well as its 1980s money supply targeting without floating rate has busted the national currency for decades and made it impossible to run budgets, made it difficult for people build houses which are now to be taxed, and also for millions to live and work in the country of their birth.

Fiscal metrics deteriorate each time rate cuts drive the country into currency crises and new taxes are brought in stabilization programs, ousting reformist governments and leading to policy reversals.

Sri Lanka’s citizens have suffered for decades from the privilege given to a few macroeconomists to print money to cut rates with inflationary open market operations and trigger forex shortages.

Related How Sri Lanka’s elections are decided by macro-economists and the IMF: Bellwether

Critics have pointed out that since 1954 in particular, central bank rates cuts which drive the country into external crises and the stabilization programs that follow, have been the main determinant of elections in the country and election of fringe political parties. (Colombo/June13/2024)

Continue Reading