ECONOMYNEXT – Sri Lanka has seen a resumption of interest on rupee denominated foreign bonds, as interest rates went up, and domestic credit slowed, reducing outflow of foreign exchange.
Foreign investor’s holdings of rupee bonds went up from 4.01 billion rupees on August 31, 2022 to 22.5 billion rupees on October 05.
The bonds were bought despite a threat of a second hair cut or restructuring of rupee bonds.
Rupee bonds have already been subjected to a high inflation and financial repression (IFR) hair cut with their real value almost halving as the rupee’s soft-peg with the US dollar collapsed from 180 to 360 to the US dollar.
Domestic inflation has hit 70 percent in the 12-months to August.
Foreign holdings of Sri Lanka’s rupee bonds are now at levels last seen in June 2020.
Foreign investors held large volumes of rupee bonds before the rupee started to collapse rapidly under ‘flexible inflation targeting’ perhaps the most deadly ‘impossible trinity’ style monetary regime ever cooked up by Washington-based Mercantilists.
Flexible inflation targeting involves applying aggressive open market operations to suppress interest rates with printed money to a reserve collecting peg, triggering currency crises.
Critics have said that such regimes which are an extreme example of the impossible trinity of monetary policy objectives, are easily peddled to third world nations without a strong doctrinal foundation in either sound money or classical monetary theory.
A World Bank survey showed that there was no such doctrinal foundation in the entire South Asia region, and only 2 percent of ‘experts’ were aware that balance of payments deficits were caused by central banks, indicating that the region would continue to be dogged by monetary instability for year to come.
Washington based Mercantilists including a Harry Dexter White and John H Williams first cooked up the Bretton Woods system promising ‘independent monetary policy’ to central banks that pegged to the US dollar.
To be fair however Bretton Woods central banks were also pegged to gold independently and were free to persue policies to maintain the gold peg, which was done by countries like Germany and Japan who successfully kept their pegs and Germany appreciated once.
In Sri Lanka the rupee was busted through several types of open market operations under fully discretionary policy available under flexible inflation targeting.
From 2015 to 2019 the rupee was busted from 131 to 182 by mis-targeting rates through termination of term repo deals which had dammed up liquidity earlier when domestic credit was weak, term repo auctions, overnight liquidity injections and outright purchases of bonds.
Other tools to inject money included a so-called ‘buffer strategy’ where bond were repaid with banks overdrafts re-financed with printed money and in 2018 by injecting dollar rupee swaps of the style used create liquidity and bust East Asia peg in 1997.
From early 2020 as interest rates started to go up after tax cut, a plethora of liquidity tools were unleashed on the peg.
Rupees were injected through injections made to enforce rate cuts, reserve ratio cuts and finally the most deadly tool of placing price control to cripple bond auction.
All errors in mis-targeting of rates are compensated by depreciating the currency through a ‘flexible exchange rate’, triggering social unrest and malnutrion.
The rupee fell from 182 to 360 to the US dollar from 2020 to 2022. (Colombo/Oct05/2022)