ECONOMYNEXT – Sri Lanka’s outstanding central bank credit to government has exceeded the monetary base in the second quarter of 2021 data shows as unusual money printing in modern monetary theory is being made in a combined monetary and fiscal ‘stimulus’.
By April 2020 the total money printed was calculated as 1,070 billion rupees, while the monetary base or the rupee notes in circulation and deposited was 1,031 billion rupees.
The data does not included excess liquidity deposited overnight (excess reserves or the aggregate overnight balance of the banking system); due to the way reserve money is calculated in Sri Lanka.
Most of the printed money has flowed out of the country as as a 2.3 billion US dollar balance of payments deficit in 2020, a 900 million deficit up to April 2021 and the rest remains as an increase in reserve money and excess liquidity.
After rate cuts and liquidity injections and lowered foreign reserves in past currency crises in the policy corrections have been made before credit to government rose to this level and un-encumbered foreign reserves fell to this level.
However no monetary policy corrections have been made so far.
A fuel price hike was made in June, a move that can give more revenue to the government and reduce money printing to bring some stability to the currency.
But last Friday 22 billion rupees were printed and the overnight aggregate balance of the banking system is over 100 billion rupees.
“Though the proximate cause of the current crisis is the Saubhagya stimulus involving 2019 December tax cuts or fiscal stimulus and the rate cut and monetary injections that followed the slide started earlier,” EN’s economic columnist Bellwether says.
“Sri Lanka’s monetary policy framework sharply deteriorated with call money rate targeting during the Yahapalana regime, which made it impossible to maintain currency stability even during a minor credit pick-up.
“When the middle of the policy corridor is targeted tens of billions of rupees are printed the monetary authority completely loses control of reserve money and also the exchange rate.
“In a second policy deterioration the policy corridor was narrowed from 150 to 100 basis points, which meant that even if middle of the corridor targeting is stopped, the correction would be small.”
“A third was the jettisoning of the bills only policy. All these changes meant that the central bank ended up monetizing past deficits and it was difficult to recover from the policy errors made.”
With call money-rate-targeting-with-excess-liqudity the gap between soft-peg crises has roughly halved to two from about 4/5 years with targeting a ceiling rate with liquidity shortages.
From 2015 to 2021 the rupee has fallen from 130 to 200 to the US dollar.
The central bank’s net foreign assets are now around 30 percent of forex reserves. The spikes in net foreign reserves, expressed in rupees, seen in 2020 were partly due to a steep fall in currency.
The excess liquidity and injections have had unusual effects including the acceleration of US dollar yields above rupee yield and discounts in forward leg of the exchange rate in swaps.
Amid interbank trading restrictions, banks are also finding it difficult to accommodate requests for letters of credit with customers using excess money printed by the central bank. (Colombo/June22/2021)