ECONOMYNEXT – Sri Lanka’s rupee weakened to new lows with the US dollar quoted around 190.50 to 191.00 levels in the spot next market and one weeks offered around 193 levels, dealers said, amid record money printing and low interest rates.
Market activity was patchy with sporadic quotes in the spot next markets, though there were offers at around 193 in one week forwards, market participants said.
Commercial bank average selling rate for US dollars reported by the central bank which was 190.37 at on Monday December 21, had weakened to 193.05 by Wednesday.
The rupee is hitting lows not seen since the March-April credit spike and money printing.
Sri Lanka has been printing record volumes of money in 2020 under Modern Monetary Theory, leading to downgrades and steep rises in the yields of sovereign bonds.
The printing has pushed rupee interest rates down and pushed up dollar yields as banks bought sovereign bonds and also found difficulties in rolling over credit lines.
In the absence of money printing and an interest rate that matches the financial account, bank purchases of bond would automatically lead to a contraction in imports as domestic credit is turned from consumption and domestic investment to the purchase of bonds or debt repayment.
Exporters have also been lending money to banks and borrowing rupees due to out of line rupee interest rates, instead of selling in the spot of forward market. Money printing has inverted forward rates making it no longer attractive to sell forward.
The purchase of sovereign bonds maturing in 2021 by banks would be equal to domestic financing of the debt as maturing proceeds would remain in the country which the government could borrow if necessary.
“The process is somewhat equivalent to the government borrowing dollars, such as through a Sri Lanka Development Bond) domestically and paying off a sovereign bond in 2021,” says EN’s economics columnist Bellwether.
“In the absence of money printing, bank purchases of sovereign bonds would perfectly offset domestic credit and imports and effectively finance the bond repayment.
“In Sri Lanka due to Keynesian Mercantilism the link between domestic credit and the balance of payments is not understood. That domestic rupee borrowings offsets imports is not understood.
“In order to be able to repay foreign loans and avoid sovereign default the government should have successful domestic rupee bill and bond auctions.
“If bond auctions fail and bills are purchased by new rupees expanding reserve money and excess liquidity there will be forex shortages. Failed bill and bond auctions are a root cause of forex shortages, foreign reserve losss, which makes sovereign default more likely.
“In a country steeped in Mercantilism, this is a difficult concept to grasp.
“Keynes also never understood the link, which led to the misunderstanding about a non-existent ‘transfer problem’. As a result there is a lost generation of economists or Mercantilists, forex shortages and sovereign default.”
A record series of bill auctions had failed recently, adding to excess liquidity as debt paper was turned into reserve money. In December alone the Treasury bill stock went up from 616 billion rupees to 644 billion.
Though there is also an increase in real money demand in the month, it could be easily met from the existing excess liquidity.
“The truth is that the maintenance of monetary stability and of a sound currency system has nothing whatever to do with the balance of payments or of trade,” explained classical economist Ludwig von Mises over half a century ago, about Germany.
“If a country neither issues additional quantities of paper money nor expands credit, it will not have any monetary troubles.”
“An excess of exports is not a prerequisite for the payment of reparations (debt repayments in the case of Sri Lanka). The causation, rather, is the other way round. The fact that a nation makes such payments has the tendency to create such an excess of exports.”
“There is no such thing as a ‘transfer’ problem.”
Further Reading : The Reparation Problem: A Discussion
Analysts had warned in early 2020 and late 2019 that the obsession would low interest rates and continued monetary indiscipline by authorities would lead to downgrades and external instability.
In the secondary securities market, bond yields remained unchanged in dull market trade, dealers said.
The secondary bond market continued the dull sentiment during the day amidst the upcoming festive season while the yield curve remained broadly unchanged, dealers said.
A 2-year bond maturing on 15.12.2022 closed at 5.70/75 per cent on Wednesday, up from 5.67/75 per cent from Tuesday’s closing.
A bond maturing on 15.01.2023 closed at 5.73/80 per cent on Wednesday, steady from 73/78 per cent from Tuesday’s closing.
A bond maturing on 15.09.2024 closed flat at 6.42/47 per cent on Wednesday from yesterday’s end.
A bond maturing on 01.05.2025 closed flat at 6.50/60 per cent from yesterday’s end.
A bond maturing on 01.02.2026 closed flat at 6.75/85 per cent from the previous day’s end.
A bond maturing on 15.08.2027 closed flat at 7.15/20 per cent.
A bond maturing on 01.07.2028 closed flat at 7.23/30 per cent, unchanged from the previous day’s end.
A 10-year bond maturing on 15.05.2030 closed unchanged at 7.75/90 per cent from Tuesday’s closing. (Colombo/Dec23/2020)