ECNOMYNEXT – Sri Lanka’s currency notes held by the public has risen sharply during a Coronavirus pandemic, a top central bank official said, as the monetary authority injected liquidity through multiple means triggering balance of payments deficits and a domestic debate.
Currency in circulation expanded from 678 billion rupees by the end of 2019 to 834.8 billion rupees by the end of 2020 or 156.8 billion rupees and another 94.5 billion rupees by July 07.
“Essentially this has been caused by the general public holding more currency rather than returning to the banking system,” Central Bank’s Director of Economic Research Chandranath Amarasekera said.
“Usually what we see in other years is that currency in circulation increasing in festive period and declining later on. But we haven’t seen this happening since the outbreak of the Covid pandemic in early 2020.”
Public holdings of cash go up in economic uncertainty due to a ‘precautionary motive’ of. Some classical economists also call it ‘private sector sterilization.’
Though rising cash holdings of the public (a real demand for notes) is not inflationary, and can absorb money printed for deficit financing and prevent a collapse of the exchange rate and balance of payments deficit.
However rising prices after currency depreciation also tends to push up cash holdings and expand the monetary base as the money required for daily transaction rise.
Sri Lanka in 2020 cut the statutory reserve ratio (commercial bank compulsory deposits at the central bank) releasing more cash to banks and also injected cash through outright purchases of government securities.
Meanwhile cash was withdrawn from the system in 2020 by a reduction in provisional advances, of 83.5 billion rupees as state revenues took a hit in 2019.
The provisional advance is a tool built in to Sri Lanka’s central bank by its creator US money doctor John Exter to advance 10 percent of expected revenues to the government for only six months in the hope of ending permanent monetization of debt and a loss of convertibility or depreciation.
A similar tool was built into Indonesia’s central bank after independence. Indonesia’s central bank is among the worst in East Asia, and the Rupiah suffered the worst during the East Asia crisis.
However it has performed better than the one in the Philippines, which was re-built after going bankrupt also created by Exter, and the one in Korea created by his colleague Arthur Bloomfield to issue Hwan currency which was went bust and a new currency (won) was re-created from scratch.
Though provisional advances are supposed to be returned in six months, in practice they have continued to accumulate, subject to a paper reversal every six months which does not disturb the monetary base or the banking system.
Up to July 2021, 45 billion rupees had been injected to the banking system through provisional advances.
The paper reversal at the end of June led to strong interest among central bank watchers in Sri Lanka who are not familiar with the operations of the central bank but are keenly watching the rising Treasury bill stock as reserves are lost, import and exchange controls are imposed and dollars rationed.
The bill stock which is the main domestic asset through which liquidity is injected to drive credit, pressure the peg and ultimately trigger a balance of payments deficit when it is redeemed against forex reserves.
If the liquidity redeemed against reserves (peg is defended) in relation to a trade transaction, the external current account deficit will also rise.
Sri Lanka has printed money, sold Treasury bills to the central bank and repaid some foreign debt, running down reserves.
Sri Lanka ran 2.3 dollar BOP deficit in 2020 and about 929 million up to April.
Central Bank credit to the government (generally referred to as money printing in a pegged exchange rate arrangement) rose risen by 506.8 billion rupees in 2020 and another 185.2 billion rupees or 1,055.5 billion rupees by July 07.
Classical economists call such policies inflationary policy.
In contrast in 2019, claims on government fell from 473.1 billion rupees to 363.5 billion rupees, in what is generally called deflationary policy.
However the policy ended in July 2019, ending the build-up of monetary reserves, analysts have shown, when so-called ‘output gap targeting’ began.
Under the last Yahapalanaya administration a ‘bills only policy’ established by then central bank Governor A S Jayewardene who ended runaway inflation and strikes was jettisoned.
Jayewardene also used to sterilize provisional advances within days of them being advanced, long term watchers of the central bank say.
The most successful East Asian central banks built large reserves by running consistent deflationary policy by selling sterilization securities to build large forex reserves. The People’s Bank of China also built reserves with a very high reserve requirement running up to 20 percent.
US mercantilists had falsely labeled East Asian deflationary policy which led to very strong currency pegs as ‘undervaluation’ which is usually hyped up by Western media who have little or no knowledge of how pegs work, according to critics.
In contrast Latin American central banks run inflationary policy – usually by failing to roll-over sterilization securities as the economy recovers strongly and not due to budget problems – triggering monetary meltdowns.
Collapsing Latin American central banks were styled on the Argentina central bank set up by its creator Raoul Prebisch, and duplicated by the Fed’s Latin America unit chief Robert Triffin. Some were set up after Triffin left the Fed and Prebisch was sacked from the Argentina central bank.
Sri Lanka’s central bank’s Treasury bill stock rose by 650 billion rupees in 2020 and a further 196.7 billion rupees by July 07, data show.
There is a mis-match between actual monetization of debt and the net credit to government, due to the way Treasury bills are accounted for in money supply calculations.
In Sri Lanka excess overnight liquidity is not considered reserve money though the money is available for final clearing of transactions of the economy every day.
By the end of 2020, 208 billion rupees of excess liquidity remained from Treasury bill acquisitions and other operations, which had been reduced to 91.5 billion rupees by July 7, through combination of a BOP deficit and rise in note holdings. (Colombo/July15/2021)