Sri Lanka forex reserves fall to US$7.6bn in September 2019

ECONOMYNEXT – Sri Lanka’s gross official foreign reserves fell 886 million US dollars to 7,637.6 million US dollars in September 2019 from 8,523.7 million Us dollars in August, official data show.

Sri Lanka gross official reserves are made up of both central bank’s monetary reserves bought from operating a peg to inject base money, and International Monetary Fund loans, earnings on reserves and borrowed fiscal reserves of the Treasury.

Gross official reserves can fall without any balance of payments pressure (monetary instability when Treasury reserves are used to repay loans.

Analysts have pointed out that a period of monetary instability began after July, when the central bank started to print money though bill and bond purchases.

When money is injected through bond purchases, the central bank loses the ability to collect forex reserves and bring the likelihood of a sovereign default closer, critics say. The recent reserve fall also has some monetary reserve losses, data show.

Until July 2019 the central bank was operating prudent policy, buying dollars through a strong side convertibility undertaking, injecting base money and mopping them up.

In June the central bank bought 87.5 million dollars from commercial banks on a net basis and in July 128 million US dollars.

Transactions with the Treasury are not disclosed.

However in July, the central bank abandoned prudent policy aimed at monetary stability and stopped mopping up base money and allowed excess liquidity to build up.

From August the central bank started printing money, through outright purchase of bills with printed money as well as term operations, apparently to push the call money rate down, in 180 degree reversal of policy, analysts have pointed out.

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Up to July the central bank draining rupees injected from a strong side convertibility undertaking, to keep rates above the policy deposit rate (floor of the policy corridor).

In August the central bank sold 76.5 million dollars to defend the peg, after the rupee fell apparently in a ‘disorderly fall’ of the currency peg. The central bank had also bought 5 million dollars from commercial banks.

It is not clear whether the dollar were bought early in the month or after the ‘disorderly fall’.

Sri Lanka’s rupee has fallen steeply under the latest re-incarnation of a soft-peg labeled the ‘flexible exchange rate’ where longtime watchers of monetary instability have found both money (liquidity management, and exchange (convertibility undertakings) policies that are against currency and monetary stability.

From 2015 to October 2019, the rupee fell from 131 to 182 to the US dollar, with two currency crises coming in quick succession.

Analysts have pointed out that it is difficult to depreciate the currency when private credit is weak (there was spike in credit in June) but it is accomplished by operating skewed convertibility undertakings and expansionary open market operations.

The strong side convertibility undertaking is deployed immediately whenever the peg strengthens without any ‘disorderly appreciation’ and base money is injected, but the weak side convertibility undertaking is not deployed to defend the peg and withdraw base money with the same zeal.

Base money withdrawals are delayed until there is a disorderly fall, Even then any liquidity shortage is instantly injected to target the call money rate, while liquidity from base money injections are kept unsterilized for long periods, until the currency weakens from a temporary credit spike.

In September the central bank had bought 2 million US dollars. It is not clear whether the dollars were bought after a ‘disorderly appreciation’.

Analysts have also pointed out that the central bank injects large volumes of base money by purchasing dollars at market rates from the Treasury with no ‘disorderly appreciation’ in another anti-rupee policy.

Anti-rupee policies are also practiced through rupee/dollar swaps with the Treasury, in the style that speculators used to hit pegs during the East Asian crisis analysts have pointed out.

After printing money and operating skewed convertibility undertakings, currency collapses are usually blamed on imports, the trade deficit or the current account deficit. (Colombo/Oct14/2019)

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