Sri Lanka forex reserves rise to US$6.4bn in July

ECONOMYNEXT – Sri Lanka’s forex reserves rose to $6.485 million in July 2016, from $5,295 million in June, following the sale of a $1.5 billion sovereign bond, official data showed.

Official reserves are made up of fiscal and monetary reserves with the central bank.

The bond proceeds are kept as dollars as fiscal reserves to meet future debt repayments, Deputy Governor Nandalal Weerasinghe said.

While fiscal reserve can be kept until they are needed.

But dollars sold by the Treasury to the central bank in return for rupees can only be kept until the Treasury spends the rupees and they later come up for redemption in forex markets as imports.

In order to keep the dollars in central bank reserves, the accompanying rupees have to be sterilized (mopped up) before fresh credit is created.

Sri Lanka’s lost nearly $3 billion of monetary reserves during the current balance of payments crisis, as the central bank released liquidity and printed new money, outright injecting rupee reserves into banks to trigger unsustainable credit and imports over 2015.

The haemorrhaging of monetary reserves have eased over the past two months, with higher market interest rates and banks increasingly raising their own deposits to finance credit instead of created rupees.

However, the banking system and primary dealers are still borrowing printed money from the central bank’s reverse repo window and auctions.

But the central bank had not finally accommodated or validated the borrowings by permanent purchases of Treasuries, keeping the pressure up on banks and primary dealers to raise real deposits finance their credit.

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Over the past six weeks the Treasury bills holdings of the central bank have remained around 270-290 billion rupees.

Total credit from the banking system to the economy also fell to record lows of Rs29.3 billion in April 2016 and Rs44.6 billion in May, compared to over Rs100 billion a month in recent months, pressure on the balance of payments has eased somewhat.

In May, there were net forex purchases of $87 million from commercial banks, and in June, there was $194 million in sales, but also $178 million of purchases. Transactions with the Treasury are not published.

Last month, policy rates were raised by 50 basis points to 8.50 percent. But money is still injected overnight through reverse repo auctions at 8.30 percent.

Sri Lanka has a ‘managed float’ or ‘soft peg’ where any attempts to target interest rates, broad money or any other monetary aggregate through the purchase of domestic assets by the central bank generates unsustainable credit and imports, de-stabilizing the monetary system.

Its fallouts are inflation, forex shortages, currency collapses and capital flight by panicked bond holders.

But since its creation the agency has followed broadly such policies. (Colombo/Aug07/2016)
 

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