ECONOMYNEXT – Sri Lanka’s gross foreign reserves grew marginally to 3,562 million US dollars in October from 3,540 million US dollars in September after falling in the previous three months, in the wake of a reserve ratio cut.
Sri Lanka cut the statutory reserve ratio in August dumping large volumes of liquidity into the interbank market, though the central bank sold some of the bills it bought in the previous two years to target potential output and trigger a currency crisis and mop some of it up.
The central bank’s reserve collections slowed or fell especially after June as the initial confidence in the currency weakened as the agency moved to the confidence busting ‘flexible exchange rate’ that is found in most defaulting countries in Africa and Latin America that go to the IMF.
The central bank’s net foreign assets also fell in September, indicating a rise in borrowings.
There have been several one-off events in the period linked to debt restructuring, in the period which has cost reserves.
However private credit is expected to pick up in the months ahead, leaving less room for mis-targeting rates.
Analysts have called for the central bank’s powers to borrow through swaps to be outlawed as part of measures to prevent a second sovereign default, stop social unrest and high nominal interest rates though monetary instability.
Under a new monetary law backed by the IMF, the central bank can continue to borrow through swaps and ‘print’ money also also print money to sterilize outflows and mis-target rates.
Meanwhile, printing money to target potential output (a so-called John Law clause/IS-LM) which was dis-allowed under the previous law but practised in the run-up to sovereign default, has been legalized giving more room to continue to deny monetary stability for either economic agents or elected governments to operate, critics say.
Sri Lanka’s reserve collecting central bank tends to cut rates, print money through open market operations to enforce the rate cut and miss reserve targets in the second year of an IMF program, as credit picks up, analysts have warned.
Interest rates cannot be kept low with open market operations, but only through maintaining stable exchange rates (and the consequent low inflation) for a few years and keeping the currency stable in the next Fed cycle by timely hikes in rates.
In addition to printing money for growth, the central bank has also got legal powers to print money to boost inflation to 5 percent which is more than twice the level of central banks which provide monetary stability to economic agents, under the new IMF backed law.
IMF-prone central banks tend to go back to the agency, a phenomenon known as recidivism (or Many Happy Returns), due to running operational frameworks which try to defy laws of nature, generally known as the impossible trinity of monetary policy objectives or IS/LM-BOP, in the process of either targeting potential output or cutting rates with inflationary open market operations claiming inflation is below target.