ECONOMYNEXT – Sri Lanka’s imports have started to rise with a pick up private credit over the fourth quarter of 2020 official data shows, with the threat of over 1.2 billion dollars worth excess liquidity in the credit system.
Sri Lanka’s credit and imports collapsed after March 2020 amid lockdowns and a consumption hit.
Credit surge in March under a so-called ‘flexible exchange rate’ also promoted by the International Monetary Fund, where the central bank prints money and delays the defense of peg until the market participants are in full panic mode.
A peg defense is then made under a shifting convertibility undertaking called a disorderly market conditions (DMC) rule, critics have pointed out.
Sri Lanka placed import control in April despite the credit collapse and is now promoting ‘import substitution’ trapping consumers and losing state revenues, which in turns leads to more money printing.
Imports fell to below a billion US dollars in May and June as credit contracted and tourism receipts disappeared and export receipts also fell.
Sri Lanka has a history of controlling or blaming specific imports for currency troubles in a Mercantilist knee jerk reaction, though it is monetary phenomenon coming from over-issue of money and credit in a pegged exchange rate regime.
Cars, gold and oil have been a favourite target of Mercantilists in the past.
The free trade agenda of the 2015 – 2019 administration was torpedoed by liquidity injections and also dollar-rupee swaps in the style used by speculators to hit East Asia pegs, analysts have said.
Imports generally keep pace with exports, remittances and tourism receipts as the recipients of the inflows spend the money, creating a trade deficit but no currency pressure.
Most members of the public are net savers in the banking system, which is used by firms and borrowers to invest or by the state to finance budget deficits, triggering imports.
Member of the public including some firms are also buyers of Treasury bills and bonds, again contributing to saving and not imports.
Government foreign borrowings and foreign direct investments create a current account deficit, though Mercantilists and bureaucrats blame the public.
However foreign financed deficits, while driving an external current account deficit, do not depress a pegged exchange rate in the absence of money printing.
External current account deficits are a result of a savings-investment gap which is financed from abroad. Mercantilists, including President Donald Trump found it impossible to understand.
“The U.S. private sector generates a savings surplus — that is to say, private savings exceed private domestic investment — so it actually reduces (makes a negative contribution to) the current account deficit,” Economist Steve Hanke explained as Trump ratcheted demonized imports.
“The government stands in sharp contrast to the private sector, with the government accounting for a cumulative savings deficiency — that is to say, government domestic investment exceeds government savings, resulting in fiscal deficits — that is almost twice the size of the private‐sector surplus.
“Clearly, then, the U.S. current account deficit is driven by the government’s (federal, plus state and local) fiscal deficits.”
Related Link: Why the Trade Balance ‘Mystery’ Is Not a Mystery
In Sri Lanka the government also runs a deficit in the current account of the budget, while members of the public save money and buys Treasury bills.
A pegged exchange rate is hit by credit or spending coming from printed money (new loanable reserves injected to the banking system) which allows banks to give loans beyond the deposits they collect.
The central bank now buys Treasury bills to create new money, instead of selling bills and giving newly minted money to previous holders of bills, driving up excess liquidity. Excess liquidity in the banking system was 225 billion rupees on December 17, down from 242 billion rupees on December 17.
Liquidity injections will drive credit and demand beyond any extra inflows that come. A steady drop in liquidity usually points to peg defence but in December the public withdraws cash.
In 2020 Sri Lanka’s government has been unable to raise large volumes of foreign debt, which will tend to contract the current account deficit. However some of the repayments have been made using foreign reserves, shielding the domestic credit system from tightening. (Colombo/Dec18/2020)