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Tuesday May 11th, 2021

Sri Lanka rupee in new equilibrium after ‘float’: Deputy Governor

ECONOMYNEXT – Sri Lanka’s rupee is in a new equilibrium after a ‘float’ in September, with the currency down 7 percent against the US dollar over 2015, Deputy Governor Ananda Silva said.

He said the economy was expected to grow by 5.7 percent and the current account deficit to narrow to 2 percent of gross domestic product.

Silva told an economic forum by Colombo-base DFCC Bank that private credit was about 307 billion rupees so far this year and the monetary authority originally expected private credit to grow by around 400 to 450 billion rupees.

State and state enterprise credit was also strong.

He said there was strong credit for vehicle purchases, partly due to a salary hike given to state workers and they higher loan to value ratio was expected to bring results.

Rate will be raised if private credit continues to be strong, he said.

Analysts who watch the Central Bank’s balance sheet has warned that the attempted float has failed and reserve losses are continuing due to monetization of debt. Though a large foreign exchange purchase was sterilized on October 19, data released on October 23 showed continued monetization of debt.

A central bank that prints money through domestic operations in a large scale (purchases of Treasury bills) has to redeem them through foreign exchange operations (defending the peg) to prevent the currency falling and inflation going up.

Sri Lanka’s foreign reserves were down to 6.8 billion US dollars in August from 9.1 billion dollars a year earlier, with 1.5 billion US dollars borrowed from India, indicating a reserve losses of 3.8 billion US dollars.

The Central Bank had released about 300 billion rupees of liquidity in a ‘quantity easing’ type of manourvre, a deadly exercise to engage in with credit is positive and fiscal policy deteriorates and printed another 170 billion rupees outright over the period.

The liquidity releases pushed up credit, resisted a rise in interest rates and a contraction in the monetary base, and eventually triggered capital flight.

Analysts who watched Sri Lanka’s soft-pegged Central Bank’s tendency to delay interest rate hikes and sterilize forex sales warned as far back as November 2015 when the current credit cycle started that a series of policy errors may generate BOP pressure and capital flight (Sri Lanka may lose forex reserve beauty contest amid ultra-low interest rates) again.

Analysts have called for fundamental reforms of the Central Bank or the outright abolition of the agency to recreate a currency board to prevent its ability to destroy the currency and generate high inflation balance of payments troubles, poverty and real capital destruction, by printing money to manipulate rates.

Central Bankers in Sri Lanka point to other soft-pegged countries in Asia like Indonesia (a perennially unstable down crawling peg much like Sri Lanka), Malaysia, Thailand or China, though its currency has appreciated sharply since 2006.

Hong Kong’s dollar has remained 7.75 to the US dollar since 1982 but it is generally ignored as economists cannot talk about trade deficits, current account deficits or ‘overvalued’ currencies or other Mercantilist fallacies about Hong Kong without facing ridicule.

Currencies of Hong Kong, Macau (hard pegged to the US), Brunei (hard pegged to Singapore) and even Nepal rupee and Bhutan Ngultrum (strongly pegged to Indian rupee for decades) are ignored in media reports and debates about Asian currencies. Bhutan also has currency competition.

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