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Sunday January 29th, 2023

Vietnam REER ignored by IMF buoying US Mercantilists as Sri Lanka rupee falls

CHERRY PICKING: Vietnam’s Real Effective Exchange Rate is over 130 but Mercantilists insist the Dong is ‘undervalued’ using cherry picked methods.

ECONOMYNEXT – Washington-based International Monetary Fund has claimed that the external position of Vietnam was too strong and appeared to support false US allegations of undervaluation by ignoring a sharply appreciating real effective exchange rate index.

Instead the IMF used another model based on the external current account to support the charge and advocated a non-credible ‘flexible’ exchange rate for Vietnam.

Sri Lanka followed unusually discretionary policy involving a ‘flexible exchange rate’ (no credible external anchor) and ‘flexible inflation targeting’ (no credible domestic anchor) and is now on the brink of default and balance of payments deficits after repeated currency crises.

Sri Lanka was hit by credit downgrades in several ‘flexible exchange rate’ episodes involving call money rate targeting with excess liquidity and over-sterilizing outflows and under-sterilizing inflows which led to steep currency falls and foreign reserve depletion.

Sri Lanka’s troubles partly came by targeting REER, which analysts had warned was a wild goose chase as East Asians nations, from Singapore to Hong Kong (currency boards), and Thailand to China (tighter than currency boards but not as credible) usually had high real effective exchange rates.


Sri Lanka’s path to debt and destruction paved by currency collapse, REER targeting: Bellwether

Sri Lanka’s devaluationist REER targeting is a tiger’s tail: Bellwether

Credible and Consistent Policy

The State Bank of Vietnam has been running a fairly credible peg with the US dollar around 23,000 dong since the last currency collapse during the start of the ‘Great Recession’ where the country was misled into ‘stimulus’ as a Fed fired bubble collapsed.

The SBV in general has been running credible domestic operations involving sterilizing inflows and only partially sterilizing outflows through a wide policy corridor and two way simultaneous lender of last resort auctions which allows the call money rate to go up and liquidity to tighten when the Fed tightens.

However the ceiling policy rate has come down since the last currency crsis.

Such a regime tends to be tighter than a currency board, which are policy-neutral and reserve accumulation is limited to domestic reserve money growth.

Unlike currency boards, such pegs can collapse after two or three Fed cycles when ceiling rate is too low to slow domestic credit or when central bankers who ran credible domestic operations retire and their replacements fall prey to relentless Keynesian pressure from the IMF and other interventionists.

“Vietnam’s external position in 2019 was assessed to be substantially stronger than warranted by fundamentals due to structural features,” an IMF staff report claimed.


The claim came shortly after the US Treasury labeled the country a ‘currency manipulator’ after a decade of currency strength, along with the Swiss Franc, one of the world’s strongest currencies.

The IMF has been pushing Vietnam to adopt a Sri Lanka style ‘flexible’ inflation targeting framework earlier claiming it would give better domestic stability than an external anchor, despite countries in Latin America turning into basket cases under similar arrangements.

US classical economist Steve Hanke from the John Hopkins university said the Amercian Treasury tended to make false charges about ‘undervaluation’ agaist trade partners with strong curencies all the time starting from Japan.

But labelling the Swissie, one of the strongest currencies in the world was a absurd, he said.

“The absurdity of putting the Swiss franc and the dong in the same basket brings back memories of May 1, 2002,” he wrote in December 2020.

“That’s when I appeared before the Senate Banking Committee, along with then-Treasury secretary Paul O’Neill, to testify on exchange rates and the Treasury’s “Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States.”

“I was highly critical of both the entire concept and the particular methods used to label a country as a currency manipulator. I indicated that the U.S. Treasury’s report was little more than an invitation for political mischief that would interfere with free trade.

“In short, I thought, and think, that the entire semi-annual currency-manipulator ritual is rubbish and should be trashed. The Swissie-dong odd couple certainly suggests that I am on to something.”

Vietnam had insisted that the strong Dong was for domestic stability and not to ‘undervalue’ the currency to boost exports.


Vietnam monetary policy for stability not trade PM tells Trump after false US charges of Dong ‘manipulation’

Trump-style Mercantilists have long falsely blamed East Asia, which has pegged exchange rate central banks and currency boards for ‘undervaluing’ their currencies and creating a trade deficit with the US.

“Noting the staff’s assessment that Vietnam’s external position was substantially stronger than warranted by fundamentals and desirable policies, Directors called for steadfast reform efforts
to remove the remaining barriers to private investment and enhance social safety nets,” IMFs executive directors, one of whom is from the US said.

“At the same time, some Directors urged caution in interpreting EBA model results, which may not
adequately capture Vietnam-specific structural factors and measurement issues. ”

The US Treasury believes that ‘price effects’ are responsible for East Asian export performance, in the Keynesian tradition, and refuses to acknowledge that the American trade and current account deficit is caused by US deficit spending and FDI receipts and instead blames East Asia for ‘undervaluation’.

Cherry Picking Models

The IMF conveniently ignored Vietnam’s Real Effective Exchange Rate Index (REER) which is currently around 130 percent (as the US had always done) and instead points to the current account surplus, cherry picking the model to support a pre-conceived conclusion.

Vietnam’s current account surplus spiked in 2019, after policy automatically tightened in 2018 in response to US tightening (quantity tightening and rate hikes) slowing domestic credit, an apartment and property bubble.

Domestic credit slowed sharply to 12.8 percent in 2018 and 2019 from around 18 percent earlier, as the call money rate rose (without a formal rate hike) and liquidity tightened.

Reserve accumulation slowed sharply in 2018, and reserves were sold to keep the peg around 23,000 giving domestic stability.

The external current account balance which was a negative 0.6 percent in 2017 with 17.4 percent credit growth expanded to 1.9 percent in 2018 and 3.8 percent in 2019. Vietnam stocks collapsed as liquidity tightened and then recovered.

The property bubble moderated allowing the economy to grow steadily with low inflation only a little higher than the US.

The IMF however has been pushing the SBV to adopt a ‘flexible exchange rate’ which reduces credibility, panics domestic and foreign investors and ultimately generates credit downgrades and political instability as had happened in Sri Lanka and Malaysia.

“In the context of reserve adequacy, Directors welcomed efforts to allow greater two-way exchange
rate flexibility and modernize the monetary policy framework, which would help the economy
to adjust to the changing external environment,” IMFs executive director said.

Vietnam’s REER is now around 130 percent.

Price Effect Mercantilism

However the IMF – as it had done to other countries in the past – focused instead on a current account based model to bash the country to claim that Vietnam’s external position was “substantially stronger than warranted by fundamentals due to structural features.”

The IMF was set up by an arch New Dealer Harry Dexter White. New Dealers devalued the US dollar as part of several economic shocks (Regime Uncertainty) that delayed and killed the first US recovery from the Great Depression.

“There is no structural feature in the Vietnam other than prudent domestic operations,” EN’s economics columnist Bellwether said.

“This goes backs to Keynesian/Mercantilist mis-understanding of the balance of payments and central banks involving the German reparations payments.

“Keynes in 1929 claimed in several intellectual debates made similar arguments placing price effects over income, which he did not appear to grasp very well.

“He also believed that there were ‘structural features’ that doomed countries.”

Keynes has written among other things that ‘the economic structure of a country in relation to the economic structure of its neighbhours permits of a certain natural level of exports.”

Swedish economist Bertil Ohlin (and French Economist Jacques Reuff) explained in 1929 that a current account surplus (or any net position) is triggered by income effects (outflows) rather that price effects warning that a focus on ‘price effects’ would have unfortunate consequences in the future.

He warned that the apart from clearing up theory, it was a “matter of considerable practical importance not only for handling of the reparation payments, but also for central bank policy in the future.”

Prophetically countries like Sri Lanka in 2015 to 2020 is facing Weimar Republic style default, amid a relentless push to run ‘flexible exchange rates’ while pumping liquidity to target an output gap and create deficits of not just the current account but the overall balance of payments. (Colombo/Mar03/2021)

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Sri Lanka exporters bring back nearly 100-pct of proceeds: CB Governor

ECONOMYNEXT – Sri Lanka exporters are bringing back almost all export proceeds, based on data generated from a monitoring mechanism, Central Bank Governor Nandalal Weerasinghe said.

Sri Lanka tightens rules on exporters and also on importers whenever the central bank prints money to mis-target interest rates and triggers forex shortages.

The rule requiring exporters to bring back dollars was put in August 2021, to his recollection, Governor Weerasinghe said.

The monitoring mechanism was put in July 2021, with some officials also claiming that there appeared to be a discrepancy between reported export numbers and conversions, firing public anger against the country’s export businesses.
“We have data from the time we started the monitoring mechanism,” Governor Weerasinghe said.

“Based on that we see that exporters have brought back almost 100 percent of proceeds as foreign exchange.”

Governor Weerasinghe was responding to a question by a Washington based agency which had claimed that there was large scale under-invoicing by businessmen who had kept money abroad.

Similar and even larger estimates had been made against other countries, he said.

Mis-invoicing is a matter for Sri Lanka Customs over had authority and not the central bank he explained.

“If anyone has any information that can reported to the Financial Intelligence, action can be taken against illegal money transfers using anti-money laundering laws,” he said.

While exporters are targeting by activists after forex shortages came, the usual accusation is that importers are under-invoicing.

Importers under-invoice to avoid excessive tax protection given to nationalist businessmen with political connection.

Protected business rake in the taxes which would otherwise have gone to the state but they escape censure. (Colombo/Jan28/2023)

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Sri Lanka operators seek higher renewable tariffs, amid exchange rate expectations

ECONOMYNEXT – Sri Lanka’s renewable companies say they need tariff of 40 to 45 rupees a unit to sell power to the Ceylon Electricity Board and the agency owes them tens of billions of rupees for power sold in the past.

The association has strong exchange rate expectations based on the country’s dual anchor conflicting monetary regimes involving flexible inflation targeting with a reserve collecting target.

“In the coming year of course because of the rupee devaluation, I think the solar energy sector might require tariffs closer to RS 40 or RS 45, hydropower will also require tariffs on that scale,” Prabath Wickremasinghe President of the Small hydropower Developers Association told reporters.

“I think right now what they pay us is averaging around RS 15 to RS 20.”

Some of the earlier plants are paid only 9 rupees a unit, he said. The association there is potential to develop around 200 Mega Watts of mini hydros, 700 to 1000MW of ground mounted soar and about 1,000 rooftop solar.

In addition to the rupee collapse, global renewable energy costs are also up, in the wake of higher oil prices in the recent past and energy disruption in Europe.

The US Fed and the ECB have tightened monetary policy and global energy and food commodity price are now easing.

However in a few years the 40 to 45 rupee tariffs will look cheap, Wickremesinghe pointed out, given the country’s monetary policy involving steep depreciation.

From 2012 to 2015 the rupee collapsed from 113 to 131 to the US dollar. From 2015 to 2019 the rupee collapsed from 131 to 182 under flexible inflation targeting cum exchange rate as the first line of defence where the currency is deprecated instead of hiking rates and halting liquidity injections.

From 2020 to 2022 the rupee collapsed from 182 to 360 under output gap targeting (over stimulus) and exchange rate as the first line of defence.

“The tariffs are paid in rupees,” Wickremasinghe said. With the rupee continuing to devalue in other 5 years 40 rupees will look like 20 rupees.”

Sri Lanka has the worst central bank in South Asia after Pakistan. Both central banks started with the rupee at 4.70 to the US dollars, derived from the Reserve Bank of India, which was set up as a private bank like the Bank of England.

India started to run into forex shortages after the RBI was nationalized and interventionist economic bureaucrats started to run the agency. Sri Lanka’s and Pakistan’s central bank were run on discretionary principles by economic bureaucrats from the beginning.

The Central Bank of Sri Lanka was set up with a peg with gold acting as the final restraint on economic bureaucrats, but it started to depreciated steeply from 1980 as the restraint was taken away.

Now under so-called ‘exchange rate as the first line of defence’ whenever the currency comes under pressure due to inflationary policy (liquidity injections to target an artificially low policy rate or Treasuries yields) the currency is depreciated instead of allowing rates to normalize.

Eventually rates also shoot up, as attempts are made to stabilize the currency which collapses from ‘first line of defence’ triggering downgrades along the way.

After the currency collapse, the Ceylon Electricity Board, finances are shattered and it is unable to pay renewable operators.

Unlike the petroleum, which has to stop delivery as it runs out of power, renewable operators continue to deliver as their domestic value added is higher.

However they also have expenses including salaries of staff to pay.

The CEB which is also running higher losses after the central bank printed money and triggered a currency collapse, has not settled renewable producers.

“In the meantime, we have financial issues with the investors and CEB owns more than 45 million rupees in the industry,” Warna Dahanayaka, Secretary of Mini Hydro Association, said at the conference.

“We can’t sustain because we can’t pay the salaries and we can’t sustain also because of the bank loans. Therefore, we are requesting the government to take the appropriate action for this matter.”

Sri Lanka and Pakistan have identical issues in the power sector including large losses, circular debt, subsidies due to depreciating currencies.

In Sri Lanka there is strong support from the economists outside government for inflationary policy and monetary instability.

The country’s exporters, expatriate workers, users of unofficial gross settlement systems, budget deficits and interbank forex dealers in previous crises have been blamed for monetary instability rather than the unworkable impossible trinity regime involving conflicting domestic (inflation target) and external targets (foreign reserves).

The country has no doctrinal foundation in sound money and there is both fear of floating and hard peg phobia among opinion leaders on both sides of the spectrum regardless of whether they are state or private sector like any Latin American country, critics say.


South Asia, Sri Lanka currency crises; only 2-pct know monetary cause: World Bank survey

A World Bank survey last year found that only 2 percent of ‘experts’ surveyed by the agency knew that external monetary instability was generated by the central bank. Most blamed trade in severe knee jerk reaction. (Colombo/Jan29/2023)

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Sri Lanka top chamber less pessimistic on 2023 GDP contraction

ECONOMYNEXT – Sri Lanka’s top business chamber said it was expecting an economic contraction of up to 2 percent in 2023, which is much lower than projected by international agencies.

“The forecast of 2023 is quite negative in terms of the international forecasters,” Shiran Fernando Chief Economist of Ceylon Chamber of Commerce told a business forum in Colombo.

“Our view is that there will be some level of contraction, may be zero to two percent. But I think as the year progresses in particular the second half, we will see consumption picking up.”

The World Bank is projecting a 4.2 percent contraction in 2023.

In 2022 Sri Lanka’s economy is expected to contract around 8 to 9 percent with gross domestic product shrinking 7.1 percent up to September.

Most businesses have seen a consumption hit, but not as much as indicated, Fernando said.

“Consumption is not falling as much as GDP in sense and we are seeing much more resilient consumer,” he said.

Sri Lanka’s economy usually starts to recover around 15 to 20 months after each currency crisis triggered by the island’s soft-pegged central bank in its oft repeated action of mis-targeting rates through aggressive open market operation or rejecting real bids at Treasuries auctions. (Colombo/Jan28/2023)

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