Sri Lanka injects Rs459bn from Feb 2020, spends US$1.3bn in forex reserves
ECONOMYNEXT – Sri Lanka’s central bank had injected 459 billion rupees in to banking system from late February to avoid selling government securities at market rates or for private credit and spent at least 1.3 billion US dollars in foreign reserves for current and debt payments, official data reveals.
The central bank has printed 227.4 billion rupees to finance the deficit (directly monetize debt) by avoiding bill or bond auctions in March and April and another 67.4 billion rupees to undermine bill auctions held and keep rates down.
The central bank also transferred 24 billion rupees in profits on February 26.
On March 13 central bank said it printed 50 billion rupees to give cash to the government ‘under exceptional circumstances’, in a lengthy statement detailing its actions after President Gotabaya Rajapaksa blamed the agency for not printing 150 billion rupees to re-finance private credit.
On March 13, another 50 billion rupees was printed for an ‘energy stabilization fund’, the central bank said.
The central bank also cut reserve ratios twice injecting 65 billion rupees in March and 115 billion rupees in June, a statement on the monetary authority’s recent actions shows.
SRR cuts while releasing liquidity and putting pressure on the currency, also takes away a structural problem in the banking system, lowering rates by increasing the efficiency of the banking system by allowing banks to lend more of their real deposits.
Many developing countries that set up soft-pegged central banks after World War II and printed money ended up with double digit SRRs as they tried to keep inflation adding to structurally high interest rates that come from chronic depreciation.
Sri Lanka slashed value added and other taxes after a new administration came into office in a ‘fiscal stimulus’ undermining state revenues, while the central bank followed up with pro-cyclical rate cuts and liquidity injections from late January, triggering monetary instability.
Injections from February to June totaled 459 billion rupees.
When loans are financed by central bank credit, a ‘foreign exchange shortage’ occurs in a pegged exchange rate regime, requiring interventions.
“Debt repayments of the government are usually settled using the government foreign reserves,” the central bank said.
“As the government could not raise adequate liquidity owing to the unprecedented adverse market conditions, the Central Bank continued to provide liquidity from the foreign reserves of the Central Bank since 08 April 2020.
Accordingly, during the period of 08 April to 22 June 2020, the Central Bank has settled US dollars 1,007 million of government debt utilising the Central Bank’s foreign reserves.”
“In order for the government to be able to buy enough foreign exchange from the market, it has to sell Treasury bills for real money through successful bond or bill auctions and reduce domestic debt or tax people to reduce their ability to consume or both,” says EN’s economic columnist Bellwether.
“Either way domestic consumption and imports are reduced.
“In countries like Sri Lanka which go to the IMF frequently there is classical economic illiteracy by definition, which results in forex shortages. Keynes also believed this. In Keynesian Mercantilism it is called the ‘transfer problem.”
“Classical economists like Bertil Ohlin tried to explain this but it is a difficult concept for anyone who believes in Mercantilism it is a difficult concept to grasp.
Singapore is now engaging in ‘stimulus’ using forex reserves directly instead of printing money and losing foreign reserves after generating monetary instability by expanding reserve money and triggering forex shortages.
That is also why Singapore avoided building a soft-pegged central bank after independence unlike many countries that became developing countries.”
“One way to try to understand this is to imagine that the economy is dollarized. While there can be sovereign default if the government is unable to sell domestic debt and raise cash (dollars) to settle foreign debt, it cannot result in a ‘forex shortage’ “, says Bellwether.
“That is why developing countries in Latin America and other countries with pegged exchange rates have to impose exchange and import controls attract downgrades and eventually default in foreign debt.”
The central bank had also sold at least 308 million US dollars in forex markets to stabilize the exchange rate after it fell close to 200 to the US dollar as market participants panicked and bank credit also soared in March amid liquidity injections.
In April private credit had fallen to low levels, data showed and the central bank bought dollars.
Known interventions totalled 1.3 billion US dollars or the equivalent of 244 billion rupees from currently available data. The central bank said it had also engaged in rupee/dollar swaps. At least 175 million in dollars had been provided by swaps, data showed.
The problem of printing money, forex shortages and difficulties making outward payments, is generally labeled the impossible trinity of monetary policy objectives by economists.
When pegged central bank prints money to keep rates down (independent monetary policy) it has to control forex flows to keep the currency from falling.
Information Minister Bandula Gunawardana said foreign exchange controls would be continued for another six months from July 02 to keep the exchange rate falling.
According to published data, there was 209 billion rupees of excess liquidity remaining in money markets by June 25.
Sri Lanka’s economic problems from fiscal and monetary stimulus comes despite making Vietnam style gains in the battle against Coronavirus.
There have been calls to reform the central bank to stop monetary instability.