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Sri Lanka sells US$174mn to defend peg in March after printing money

ECONOMYNEXT – Sri Lanka has sold 174.3 million US dollars in March 2020 to defend a soft-peg with the US dollar after printing money, to target a call money rate and generate excess liquidity, despite weak private credit, official data showed.

Sri Lanka had monetary stability until January 2020, when rates were cut on January 30 and the first so-called helicopter drop of excess cash took place in the last week of February.

In January, Sri Lanka’s central bank bought 149 million US dollars from markets and sold 60 million dollars to maintain the peg and avoid a loss of credibility in the peg.

By February, before the Coronavirus crisis, dollar sales had risen to 10 million US dollars and purchases had dwindled to only 3 million dollars.

By March, Sri Lanka was completely on the sell side, liquidity injections were ramped up as the rupee fell and by also allowing the rupee to fall, the credibility of the peg was also lost.

Any countries without a full floating exchange rate (non-internationalized currency) that engages in monetary stimulus will face foreign exchange pressure, the International Monetary Fund said.

“So, when they actually rely on large stimulus packages, they have to worry about its possible negative impact on their external sector especially the FX market,” Changyong Rhee Director, Asia and Pacific Department, IMF said on April 15.

Following changes made to the monetary framework during the tenure of Governor Indrajith Coomaraswamy involving call-money-rate-targeting-with stimulus style dumps of excess liquidity, Sri Lanka’s peg had lost the protection of the policy corridor, analysts have pointed out.

The peg broke easily in April 2018 as a result of stimulus style call money-rater-targeting and also in July 2018, when the economy recovered without any kind of external instability.

In Sri Lanka there is a strong belief that the rupee falls due to imports, the lack of trade deficit and not liquidity injections or ‘stimulus’, due to Mercantilism and lack of knowledge of classical economic theory, analysts have said.

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Sri Lanka’s politicians have controlled trade and asked the public to grow kollu (horse gram) as injections drove up excess liquidity.

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Mercantilists have also put forward a theory that the rupee fell in 2015 and 2018 due to rupee bond sales by foreigners and not rate cuts and liquidity injections, which led to a loss of credibility of the peg which triggers capital flight.

Following changes made to the monetary framework during the tenure of Governor Indrajith Coomaraswamy involving call-money-rate-targeting-with excess liquidity Sri Lanka’s peg had lost the protection of the policy corridor, analysts have pointed out.

The peg broke easily in April 2018 as a result and also in July 2018 when the economy recovered without any kind of external instability. (Colombo/Apr20/2020 – Update II)

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