ECONOMYNEXT – Sri Lanka’s central bank credit (printed money) broke records in March 2020 helping private and state credit soaring to trigger the latest run on the rupee and monetary instability that earned the country a credit downgrade, official data show.
According to official data, 164.9 billion rupees of new money was printed in March 2020, which is higher than the 122.6 billion rupees printed in September 2018 to help drive the second run on the rupee during the 2018 currency collapse.
In addition to official numbers, there were also 24 billion rupees of profit transfers made in the last week of February and the statutory reserve ratio cut which injected over 50 billion rupees helping drive excess liquidity in the latest episode of monetary instability.
In the run on the rupee which started in August/September 2018 liquidity was injected to sterilize a maturing legacy swap disturbing reserve money while more liquidity was created through dollar/rupee swaps of a type usually used by speculators to hit currency pegs.
In March 2020, private credit grew by 120 billion rupees, of which about 29 billion rupees worth was related to an expansion in foreign currency loans.
Credit to government hit a record 269 billion rupees. Total credit including printed central bank credit rose to an all-time high of 426 billion rupees.
In the first run on the rupee in 2018, private credit also soared in March and the central bank cut rates and injected liquidity and the rupee fell from 152 to around 161 in the first run.
The currency collapse in 2018, led to a slowdown in output, consumption, and bad loans in 2019.
In March 2018, the credit system was just recovering from a currency collapse from 2015/2016 which when liquidity was injected and rates cut to trigger a new round of monetary instability.
Analysts have pointed out that unlike in the recent past Sri Lanka is highly vulnerable to currency collapses due to call-money-rate-targeting-with-unlimited-volumes-of-excess-liquidity and delaying currency defense when the new cash triggers a run on the rupee calls the ‘DMC’ or disorderly market conditions rule.
The rupee is defended after importers panic and investors flee. Once the credibility of the peg has been lost, it takes a consumption collapse and a credit slowdown to stabilize the peg, which also slows the growth and triggers bad loans.
In March/April run on the rupee, curfews led to a consumption collapse though authorities also placed import curbs, hitting inputs for industries.
In the latest period of monetary instability about 140 billion rupees were also drawn out of the banking system in March and April as curfews were imposed, central bank officials have said.
Such drawdowns do not pressure the currency as they do not form part of excess liquidity that can be used to buy Treasury bills, bonds, or give private credit to generate excess demand and instability.
Excess liquidity grew from 28 billion rupees in March to 110 billion rupees on March 27. Currency defense also draws out excess liquidity.
In March 174 million dollars were spent to defend the rupee drawing out about 30 billion rupees of excess liquidity.
In March/April run on the rupee, curfews led to a consumption collapse though authorities also placed import curbs, hitting inputs for domestic industries.
Breaking from the past, the central bank has allowed the rupee to appreciate back to around 188 to the US dollar in May.
Credit to the government from the banking system including central bank credit was a record 259 billion rupees in March. Credit from commercial bank domestic units was 73.2 billion rupees. Foreign currency borrowings grew by 32 billion, at least a part of which may be related to the currency collapse.
State enterprises had also borrowed 35.7 billion rupees in March.
Out of the private credit of 122 billion rupees, a 28 billion rupee equivalent was also an expansion of dollar loans, which may be related to the currency collapse. (Colombo/Mar18/2020-sb)