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Sri Lanka’s central bank buys US$129mn to peg rupee in July

ECONOMYNEXT – Sri Lanka’s central bank has bought 129 million US dollars to peg the rupee to the US dollar with a strong side convertibility undertaking of a soft-pegged exchange rate regime, official data shows.

The central bank has generally deployed a strong-side CU (prevent appreciation of the rupee) in 2019, as bank credit weakened and credibility of the peg was restored with exporters no longer holding back dollars and importers panicking, though there is some capital exits from rupee bond markets.

In June the central bank also bought 87.5 million US dollars to enforce a strong side CU, generating excess liquidity in money markets.

Excess liquidity in money markets coming from weak private credit has lowered short term rates, and the central bank has lowered its policy corridor as rates moved towards the standing deposit rate or floor rate of the corridor.

By steadily mopping up inflows through the sell down of central bank held Treasury bills, the monetary authority has the ability to enforce a strong side CU build up reserves and generate further surpluses of dollars.

Sri Lanka’s central bank now operates a highly unstable peg with inconsistent policy which it calls a ‘flexible exchange rate’ which has brought balance of payments crises in quick succession, killing growth and panicking exporters and importers by trying to enforce a weak-side CU without a floating interest rate, critics have said.

The central bank operates several weak side CUs including explicit forward exchange guarantees (swaps), an undertaking to prevent a ‘disorderly adjustment’ of the exchange rate without a floating policy rate to enforce it.

Due to a ceiling policy rate the central bank prints money soon after buying dollars in a bid to enforce a strong side convertibility undertaking engineering a collapse of the exchange rate, analysts have showed.

Analysts have called for the policy corridor to be wide, so that short term rate will quickly move up and nip any exchange rate pressure in the bud, before exporters and importers panicked.

In 2019, there are some concerns that government borrowings will spike amid weak revenues.

There have been calls to criminalize certain actions of the domestic operations department, which prints money at below the ceiling policy rate, injects money recklessly to maintain excess liquidity despite dollar outflows, due to an apparent obsession with short term rates.

It also halted sterilization auctions suddenly in February 2018, ending monetary stability that has been maintained throughout 2017, helping trigger and economic recovery, critics have said.

In 2018 money was also injected through so-called Soros-swaps to worsen monetary instability..

In an upcoming reform to monetary law printing money through direct purchases of Treasury bills from through so-called provisional advance are expected to be outlawed.

It is not clear whether swaps would also be outlawed. (Colombo/Aug11/2019)