ECONOMYNEXT – Sri Lanka’s bonds market saw more activity Thursday after auction yields rose a day earlier after bond auctions were freed from price controls while the rupee continued to be hobbled with decreed 203 to the US dollar, despite convertibility having been suspended for trade transactions.
This week American Express, a credit card started rejecting all personal overseas transactions above 100 US dollars.
Banks are operating ‘priority lists’ after central bank stopped providing convertibility (taking rupees out and giving dollars) for trade transactions to hold the peg.
However convertibility is provided to de-stabilize the (taking dollars and creating new rupees) through a surrender requirement slapped on exporters and remittances.
At the moment however there is a liquidity short after statutory reserve ratio hike to which it can disappear. It is not clear why the SRR was hike before getting the crippled bond markets to work again.
Settlements are being done off-market among exporters and importers who are friendly. Others are on waiting lists and paying demurrage to the port.
Newly appointed central bank Governor Nivard Cabraal lifted price controls and has allowed rates to move up. Only half the offered volume of 39.5 billion rupees was sold.
However some secondary market activity had been kindled.
In bond markets a 15.07.2023 maturity which had not traded for weeks or months was quoted at 7.40/50 percent.
A 01.11.2023 bond which had also not been traded for a long time was quoted at 7.50/8.00 percent, dealers said.
A 01.12.2024 quoted at 8.30/50 around the same as yesterday’s 8.25/45 percent.
Confidence in Sri Lanka’s bonds had been badly hit by central bank purchases and liquidity injections and auction price controls, which had created the worst foreign exchange shortages since the 1970s.
The gradual collapse of the bond market started with so-called State III auctions in the last regime.
At the time it was said to have been recommended by an expert whose own country did not use such a control. The US for example has single price auctions with a portion offered for non-competitive bids.
The US Fed is now triggering inflation around the world through its Powell Bubble, making an unfunny claim that inflation is ‘transient’, criics say.
In recorded history among major central banks the Fed has been responsible for the worst policy errors.
The last one was the Great Recession from the Greenspan-Bernanke bubble also known as the ‘mother of all liquidity bubbles’, though it is not clear whether the Powell Bubble will out do it.
The Fed also created the Great Depression after the Roaring 20s or Benjamin Strong bubble, and busted a centuries old gold standard and collapsed the Bretton Woods system after the Arthur Burns output targeting debacle.
As long as bond markets do not work to channel private savings into a runway budget deficit or even monetizes debt from past deficits by placing price controls on one year bonds and above, the external sector can unravel and drive a country towards default.
Turning government securities into money
In 1951 a premature collapse of the Bretton Woods, was avoided by Marriner Eccles, a Fed Governor who was a banker who resisted pressure to buy a war finance security known as a Liberty Bond as inflation rose and price controls and rationing took place.
“There is going to be nothing for us to protect in this country unless we are willing to do what is necessary to protect the dollar,” Fed Governor Marriner Eccles who was a former chairman said in comments set out in the Fed minutes of February 6-8, 1951, which are now public.
“Our responsibility is not a minor one; it is a very great one under the conditions that exist, and if we fail, history will record that we were responsible, at least to a very great measure, in bringing about the destruction or defeat of the very system that our defense effort is being made to protect and defend.
“You only protect the public credit by maintaining confidence in the Government and in its securities and to the extent the public will buy and hold those securities. The thing we are doing is to make it possible for the public to convert Government securities into money and to expand the money supply of this country by $7 billion in six months.”
The central bank had turned over 1.3 trillion rupees into government securities since around February 2020, losing about 5 billion US dollars to a balance of payments deficits.
The balance been absorbed in an ‘internal drain’ raising public currency holdings, at least a part of which may have come from precautionary holdings from the pandemic and the rest had likely accommodated inflation, including from the weakening of the currency.
“We are almost solely responsible for this inflation…the whole question of having rationing and price controls is due to the fact that we have this monetary inflation, and this Committee is the only agency in existence that can curb and stop the growth of money,” Eccles said in 1951.
Sri Lanka is now mired in price controls. The parliament on Wednesday passed passed a law to hike fines on traders as prices off basic good rocketed and price controls created shortages.
When Eccles and Chairman Wade McCabe hiked rates, Ceylon’s newly set up central bank after abolishing had its first currency troubles and enacted an exchange control law in 1952.
Among prices that can be controlled by states, interest rate controls probably have the most dangerous effects economic activity, analysts say.
“I think that move away from the currency board to discretionary central banking was perhaps one of independent Ceylon’s, early birth defects in light of what’s happened subsequently,” Razeen Sally, a classical economist said at an event to mark 69 years of Sri Lanka’s central bank.
“What was essentially a pretty strict, a pretty strict rule regime to limit political and bureucratic discretion – very roughly equivalent to a fixed and non adjustable peg – was transformed in 1950, thanks to the design the tutelage of John Exter, let’s not forget, under a UNP government with J R Jayawardene as Finance Minister, into discretionary, central banking,” he said.
“And since then, we’ve had at least some periods where monetary policy with discretion over the rules has reinforced the mistakes of fiscal policy rather than leaning against it as it were.”
The last administration was defeated by the public as its economic program of trade liberalization and investment promotion lay in tatters amid trade controls and currency falls. (Colombo/Sept25/2021)