An Echelon Media Company
Tuesday April 16th, 2024

Sri Lanka spends US$736mn to defend 200 to dollar peg as ‘reserves for imports’ intensify

ECONOMYNEXT – Sri Lanka’s foreign reserves sales to commercial banks defend a 200 to the US dollar peg soared to 736 million dollars from September to November 2021 official data shows, forcing money to be printed to maintain a fixed policy interest rate.

In November and December alone 664 million dollars of reserves were sold to commercial banks.

The injection of money after such ‘reserves for imports’ to defend a peg (sterilization of interventions) prevents the contraction of reserve money, prevents a rise in short term interest rates, prevents a required slowdown in private credit and re-ignites demand for imports.

In a remarkable descent in to Mercantilist ideology, calls were made in Sri Lanka to spend more reserves on imports while simultaneously claims were made that a 200 to the US dollar peg was unsustainable.


Sri Lanka use of reserves for imports is a deadly false choice: Bellwether

Why Sri Lanka’s rupee is depreciating creating currency crises: Bellwether

Any reserve sales for imports is a defence of the peg, which commits a central bank with a fixed policy rate to print more money through ‘open market operations’, triggering yet more imports.

If reserves are used for imports without allowing the monetary base to fall, sovereign as well as private foreign debt default may become inevitable even if debt is re-structured, analysts have warned.

The injection of money after giving reserves for imports is the hallmark of a soft or unstable peg (now called a ‘flexible’ exchange rate), that trigger currency crises and balance of payments deficits.

A clean float (suspension of convertibility) is required to stop the cycle of sterilized interventions.

Sri Lanka required structurally higher interest rates as soon as the country was locked out of bond markets in 2020 to generate resources to repay debt. However rates were cut in 2020 amid downgrades.

Sri Lanka’s market rates have risen after yield controls were lifted, though mostly three month bills are being bought, and deficit monetization is minimal.

In sterilizing reserves for imports, liquidity is injected into commercial banks (private sector) but to later observers it appears as deficit finance, since money is printed not against private securities but government debt.

For centuries, during the gold standard era, the Bank of England used to operate its discount rate (which was not fixed) against private debt (bankers’ acceptances) which were tradable in the secondary market.

Open market operations as known today was invented by the Federal Reserve in the course of firing the ‘Roaring 20s’ bubble that led to the Great Depression. A part of the bubble involved firing up stocks with margin credit.

In the way Sri Lanka’s central bank engages in reserve sales for debt repayments against newly created Treasury bills it is possible to appropriate reserve for debt repayment without changing rupee reserves in individual banks through a series of back-to-back transactions (no reserve pass-through).

Sri Lanka created a soft-peg in 1950 ending floating short term rates and a fixed exchange rate that had protected the population from a Great Depression and two World Wars. Sri Lanka has reserves worth 11 months of imports when the soft – peg was created.

The UK around the time was facing severe currency troubles due to Keynesianism.

In November the central bank sold 310 million US dollars to commercial banks on a net basis which rose to 353 million US dollars by December.

The interventions are the highest seen since the 2018 currency crisis.

Sri Lanka’s past currency crises up to around 2005, which sent the rupee careening down from 4.70 to the US dollar to around 110 were intensified with sterilized reserve sales to defend a peg, though the crisis may have been initially triggered by budget finance or rural credit.

Amid more discretionary and contradictory monetary policy after the end of a 30-year war, involving a ‘flexible’ exchange rate and ‘flexible’ inflation targeting Sri Lanka has faced currency crises and depreciation in quick succession and the rupee is now at 200 to the US dollar.

Parallel exchange rates are around 248 to the US dollar.

The central bank has also imposed surrender requirement for exporter and remittance dollars, despite the peg being weak and requiring tighter monetary policy. A surrender requirement pushes the currency down through liquidity creation. A reserve sale can strengthen the currency as long as it is not sterilized.

In the nine months to September the central bank bought 228 million dollars on a net basis from commercial banks under a surrender requirement despite a peg having already weakened. (Colombo/Feb08/2022 – Update II)

Leave a Comment

Your email address will not be published. Required fields are marked *

Leave a Comment

Leave a Comment

Cancel reply

Your email address will not be published. Required fields are marked *

Sri Lanka State FinMin meets BCIU in US; discusses post-crisis investment prospects 

ECONOMYNEXT – Sri Lanka’s State Finance Minister Shehan Semasinghe met Business Council for International Understanding( BCIU) in Washington on the sideline of the IMF/World Bank Spring Meetings late on Monday and discussed investment prospects in the island nation which is gradually recovering from an unprecedented economic crisis.
“Our discussion centered on the potential that Sri Lanka offers for international investors. Explored various sectors, including education, tourism, renewable energy, agriculture and technology, where strategic investments can drive sustainable economic growth and development,” Semasinghe said in his X (Twitter) platform. 
“We reviewed the current macro-economic landscape of Sri Lanka, including recent reforms that have transformed to results. Glad to concluded the forum by marking constructive dialogue and a shared commitment to support the economic development of Sri Lanka.” 
“We thank participants, stakeholders holders and global partners for the significant interest shown in unlocking the full potential of the Sri Lankan economy and fostering greater international understanding and cooperation.” (Colombo/April 16/2024) 
Continue Reading

India allows Sri Lanka to import 10,000MT of onions

ECONOMYNEXT – India has relaxed an export ban allowing 10,000 metric tonnes of onions to be shipped to Sri Lanka, the Indian High Commission in Colombo said.

“The exemption for Sri Lanka reiterated India’s Neighbourhood First policy, adding to the Sinhala and Tamil New Year festivities here,” the statement said.

Onion prices went up in Sri Lanka after India and Pakistan banned exports.

The Directorate General of Foreign Trade has issued a notice allowing National Co-operative Exports Limited to ship 10,000 MT of onions.

The UAE has also been allowed to import 10,000MT of onions on top of 24,400MT already permitted.

A large Indian and South Asian expat community lives in the UAE. (Colombo/Apr15/2024)

Continue Reading

Iran President to visit Sr Lanka amid rising tension, inaugurate Uma Oya project

ECONOMYNEXT – Iranian President Ebrahim Raisi will arrive in Sri Lanka on April 24 on a one-day official visit to inaugurate Tehran-assisted $529 million worth Uma Oya multipurpose development project with 120MW hydro power generation capacity, official sources said.

The announcement on President Raisi’s visit comes two days after Iran launched explosive drones and fired missiles at Israel in its first direct attack on Israeli territory, a retaliatory strike that raised the threat of a wider regional conflict.

“The President is visiting to inaugurate the Omaoya project. He will be on a one-day visit,” an official at Iran embassy in Colombo told EconomyNext.

A Sri Lankan Foreign Ministry official confirmed the move.

This is the first time an Iranian President coming to Sri Lanka Iranian after then President Mahmoud Ahmadinejad’s visit in April 2008.

The Omaoya project was originally scheduled to be completed in 2015, but had been delayed several times due to unexpected issued faced during the project cycle and funding issue after the United States imposed economic sanctions on Iran and economic crisis in Sri Lanka.

The project was started in 2010 and the funding was to be received as loan grant from the Iranian government. However, Iran was able to provide $50 million before the sanctions. Sri Lanka has to bear the cost after the sanctions.

The project includes storing water in two reservoirs with dams before being brought through a 23 km tunnel to two turbines located underground and generating hydro power with a capacity of 120 megawatts and added to the national grid.

After power generation, the water is expected to be brought to three reservoirs while supplying water to 20,000 acres of old and new paddy fields in both the Yala and Maha cultivating seasons.

The Memorandum of Understanding (MOU) for the construction was signed between the two countries in 2007 while Sri Lanka’s Cabinet approved the execution of the contract agreement between the Executing Agency, Sri Lanka’s Ministry of Irrigation and Water Management (MOIWM) of the GOSL and Iran’s FARAB Energy and Water Projects (FC).

When commencing the project on March 15, 2010, the scheduled date of completion of the project was on March 15, 2015. But the schedule completion date was extended to December 31, 2020 due to the unexpected water ingress into the head race tunnel and followed by social impacts.

The trade between the both countries suffered after the US sanctions. However, Sri Lanka inked a deal in December 2021 with Iran to set off export of tea to Iran against a legacy oil credit owed by state-run Ceylon Petroleum Corporation to the National Iranian Oil Company.

Sri Lanka owes $251 million for crude imported before the US imposed sanctions on Iran. (Colombo/April 15/2024)

Continue Reading