ECONOMYNEXT – Sri Lanka’s forex reserves rose $165 million to $5,618 million in February 2017, from $5,453 million in January, although $297 million had to be sold to defend the currency, official data showed.
Sri Lanka has lost reserves as the peg lost credibility amid loose monetary policy, making foreign investors sell bonds, while credit growth was also driven to high levels.
In January, the Central Bank was forced to print tens of billions of rupees to repay a maturing bond, which critics say is reckless fiscal dominance, driving up credit and imports, and pushing the currency down.
Although the event effectively avoided sovereign default, money market excess liquidity surged to Rs103 billion on January 03 from Rs39 billion on December 31.
The Central Bank sold down its Treasury bill stock swiftly avoiding by not rolling over bills at weekly auctions to mop up the printed rupees, and the market became negative only on February 09.
Because Sri Lanka has a dollar soft peg, the policy rate itself is not a clear sign of whether policy is loose or tight.
Reckless fiscal dominance has underlined the importance of reforming Central Bank law to make it more independent, analysts say.
The Central Bank itself loosened policy from late November, buying up Treasury bills up to two months ahead to print money and depress bond yields.
As a result, Sri Lanka was unable to meet foreign reserve targets set by the International Monetary Fund.
In January, the Central Bank sold $297.2 million to commercial banks and managed to buy $146.5 million. Dollars flows in the Treasury are also surrendered to the Central Bank and do not show up in the data.
Forex reserves fall due to currency defence, repayments to the International Monetary Fund – which have no bearing on the domestic money base – and also currency fluctuations like a weakening Euro against the dollar and weakening the gold price.
Reserves go up when dollars are bought into the market and rupees are mopped up (sterilized forex purchases), when disbursements from the IMF are received and when earnings on forex reserves are recognized, the Euro or gold strengthens against the US dollar.
Sri Lanka’s central bank however also ‘borrows’ dollars through swaps and shows them as reserves. (Colombo/Mar13/2017)