ECONOMYNEXT – Sri Lanka and Pakistan had discussed the possibility of cross-investing foreign reserves in each others’ sovereign bonds during a visit of Prime Minister Imran Khan to the island, State Minister for Money and Capital Markets, Nivard Cabraal said.
“We have been investing foreign reserves in Western government bonds at low rates about 1.5 percent,” Cabraal told reporters in Colombo.
“They are also investing in various instruments in the Western world. They are also generating 1.5 percent, just like us. Sometimes it makes sense to invest in theirs (bonds) and for them to invest in ours.
“”But we borrow at high rates. When we give money to Western nations it is not called giving a loan but an investment.”
There was “merit” in investing forex reserves in each other’s dollar sovereign bonds up to a prudential limit, he said.
“Bangladesh central bank I know has Sri Lankan bonds,” he said. “We should look at South-South investment.”
Over the last two decades Bangladesh has had superior monetary policy running a fairly credible implicitly pegged regime, analysts say.
Many emerging market central banks which have explicit or implicit pegs countries which use the dollar as the intervention currency, also invest in Euro denominated bonds, which exposes them to high cross currency risks.
Investing in dollar bonds reduces currency risk, though default and liquidity risks may exist in low rated emerging market bonds.
Most South Asian governments have issued international sovereign bonds which are traded in key over the counter markets in Asia, Europe and the US.
Pegged central banks invest in Western government bonds because they have a high rating with low default risk and Western markets are liquid and they do not impose exchange controls.
Before 1951 when a money printing Latin America style central bank was set up by a Federal Reserve money doctor Sri Lanka had a currency board where money was created only through forex purchases (net foreign assets) keeping the exchange rate fixed from 1885 to 1951.
Its assets were invested in a number of liquid Sterling Area government securities and not just UK analysts familiar with the operations of the Board of Commissioners of Currency of Ceylon said.
Issuing domestic money only against NFA provided a non-discretionary monetary rule that allowed Sri Lanka (Ceylon) to be among highest income countries in Asia after Japan and its stock exchange to finance FDI in countries like Malaysia.
Currency Boards are not expected to have more than 115 or 120 percent of the monetary base in forex reserves and was a tool devised by British rulers to allow unit of their empire to get part of the profits of note issue.
But Latin America style pegs try to collect large reserves to run counter-cycle policy and trigger balance of payments crisis in the process of selling reserves and sterilizing interventions to resist market interest rates in the economy in pro-cyclical policy or by printing money for budgets.
After printing large volumes of money in 2020 (issuing money against domestic assets) Sri Lanka suffered its biggest balance of payments deficit in its history. (Colombo/Feb25/2021)