Sri Lanka reluctant to hike rates to fix currency pressure: report

ECONOMYNEXT  – Sri Lanka’s central bank is reluctant to hike interest rates to defend the currency as it may hurt an economic recovery, while an option remained to tighten exporter repatriations, a media report quoted Central Bank Governor Indrajit Coomarwasamy as saying.

"In our tool we have several other options too, such as changing the duration of repatriations of export proceeds and revision of interest rates to even out the differences between US rates are Sri Lanka," Sri Lanka’s Daily FT newspaper quoted Coomaraswamy as saying.

"However the monetary board is reluctant to increase the interest rates as of now because the growth of the economy is subdued though there is an uptick witnessed in the quarter."

A meeting of the rate setting monetary board has been put off to October 02, from September 28.  The rupee touched 169 to the US dollar in the spot market Thursday.

Coomaraswamy had said there was no point in defending a particular exchange rate as experience in the past has shown that it does not work, the newspaper reported.

"So trying to spend a large amount of reserves to defend a particular rate, you end up with as double whammy – depleting the reserves and eventually ending up depreciating the rupee."

There is a however a difference between defending a currency when there is excess liquidity (unsterilized defence) which tends to tighten the system and sterilized sales (defending a currency and then printing money to keep rates down) which does not help.

Most analysts agree that volumes of reserves can be lost through sterilized forex sales with no useful outcome, once the credibility of the peg had been lost.

Sri Lanka’s banking system is now facing severe liquidity shortages partly due to swap operations, which makes further defence of the currency less effective.

However analysts have pointed out that the central bank can allow interbank rates to go up to 8.50 percent without a formal rate hike and the central bank has printed money below that rate to sterilize liqudity shortfalls which may delay the stabilization of the currency.





Keeping overnight money markets short by about 20 to 30 billion rupees and forcing banks to borrow about that volume through the overnight window will also help a float take hold faster, analysts say.

Any overnight excess liquidity will not help the rupee, analysts have warned.

The central bank has been injecting cash through term reverse repo deals of up to two weeks to sterilize the liquidity shortage that has emerged. Term reverse repo deals analysts have said are better than permanent injections of cash.

When a currency panic develops, exporters will try to hold back dollars and fund daily operations with overdrafts. If money markets are kept tight, banks will have to stop other credit and fund exporters only.

If liquidity (printed money) is pumped in to maintain excess money in the banking system, banks can fund exporters and also other creditors as well, fueling pressure on the currency.

As long as exporters take loans, displacing other credit, there is no pressure on the currency, only on interest rates.

Banks also do not like to borrow large amount of money overnight and lend as there is a mismatch in their books, which is why analyst say forcing banks to borrow about 20 to 30 billion rupees overnight will help a float take hold.

Coomaraswamy had said that external factors such as rising US interest rates are also impacting Sri Lanka. Though some foreign investors have sold bond and stocks, there not been a ‘major outflow’ the newspaper report said.

 Sri Lanka had already restricted vehicle imports and put taxes on gold.

Sri Lanka’s currency instability comes from operating a so-called soft-peg where a central bank tries to target both the exchange rate and interest rates (by printing money) which cannot be done in practice especially when credit picks up.

Analysts economists have called for the soft-peg to be abolished and go back to a hard peg  (currency board) or at least take measures to improve the credibility of the peg.

Fixing the peg will also help Sri Lanka follow a free trade regime. (Colombo/Sep21/2018 – Update II)

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