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Sri Lanka forex reserves drop US$353bn to US$7.2bn in April

ECONOMYNEXT – Sri Lanka’s foreign reserves have dropped 353 million US dollars to 7,179 million US dollars, official data show, after bout of money printing led to a fall in the credibility of Sri Lanka’s soft-peg with the US dollar.

Sri Lanka cut rates on January 30 and began injecting liquidity from late February while Coronavirus curfews brought the country to a standstill in from late March.

Data in February shows a slight pick-up in credit.

In January rates were cut despite a tax cut in a Western-style fiscal stimulus, aimed a short cut to boost growth.

The rate cut came despite the existence of a soft-peg with the US dollar, which is prone to balance of payments troubles and negative output shocks that come from a consumption and credit collapse that is needed to restore credibility of the peg and re-build forex reserves.

The latest bout of money printing which led to a currency fall, intensified capital flight, soaring yields on sovereign bonds amid global uncertainty and has also earned a downgrade.

Interventions to take the edge out of the worse effects of excess liquidity, the slide of the fall was stopped at around 200 to the US dollar from 182 when injections began. Now the effects of a consumption collapse driven by curfews is being seen.

Treasury Secretary P B Jayasundera has also called on state worker to give back a portion of their salaries to curb the deficit. In countries which see external meltdowns, money printed to pay state salaries in usually the main reason for the collapse and hyper-inflation that follows.

Over the last decade, Sri Lanka’s forex reserves have failed to grow and had become more balance of payment crisis prone and susceptible to monetary instability after several changes made to the operating monetary framework.

These include the discontinuation of the issue central bank securities, attempting to target inflation despite operating a peg, and the latest deterioration of policy involving targeting-call-money-rates-with-excess liquidity, analysts have said.

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The policies, which have made it impossible to build forex reserves on a sustained basis (sterilize inflows) have kept gross official forex reserves, which includes borrowed money by the Treasury below 10 billion US dollars and net monetary reserves even lower.

In the last decade Sri Lanka has triggered balance of payments crises and output shocks by injecting liquidity against domestic credit trends in the middle of 2011, the last quarter of 2014, second quarter of 2018 and the first quarter of 2020. (Colombo/May08/2022)