ECONOMYNEXT – A non-credible peg of Sri Lanka’s rupee has been devalued to 203 to the US dollar from an earlier 202, with banks offering dollars at the new rate for customers, with the currency under pressure from liquidity injections.
Sri Lanka’s bank’s were first barred from selling or buying dollars at 199.90 to the US dollar on May 03, with banks depositing 161 billion rupees of liquidity in the central bank excess liquidity window, representing a potential pressure of around 800 million US dollars.
The non-credible peg was later devalued to 202 to the US dollar.
Despite steady weakening of the exchange rate, there are forward discounts. This week spot/one year deal was done at a 17 rupee discount, market participants said, implying around 83 rupees for one year dollars amid as domestic dollar yields rise.
Sri Lanka’s hard peg with the US dollar lost credibility in 1950 when a money printing central bank was established by a Federal Reserve money doctor in the style of several set up in Latin America by the agency from the time of the Great Depression.
When the peg lost credibility with the start of liquidity injections, which result in balance of payments deficits, the rupee was at 4.70 to the US dollar.
Until the 1967 Sterling crisis, the peg was maintained with exchange and trade controls. Until then the US dollar to Sterling parity was also fixed as the two central banks were supposed target gold under the Bretton Woods system.
Sri Lanka’s central bank was expected to target gold at 2.88 grains. The US dollar was expected to target gold at 35 dollars an ounce.
However due to output gap targeting style monetary policy – now known as ‘stimulus’ – the US dollar also collapsed in 1971, leading to a system of floating exchange rates.
Sri Lanka’s rupee has so far collapsed from 4.70 levels at the time of independence to 203 so far as money was printed (central bank credit) to keep down interest rates and drive up bank lending. (Colombo/May18/2021)