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ECONOMYNEXT – Sri Lanka recorded a balance of payments surplus in September 2022, official data shows, after rates were raised to reduce private credit, allowing the phasing out of money printing and the agency has also lacked reserve options to borrow and engage in sterilized operations. interventions.
Sri Lanka’s central bank began to lose the ability to collect reserves and manage balance of payments surpluses from around August 2019, as liquidity injections to target the yield curve began.
From December 2019 taxes were cut and from around February 2022 large amounts of money were printed and treasury bills issued to finance past and current deficits were purchased to mistarget rates.
In the 9 months to September, Sri Lanka recorded a balance of payments deficit of US$2,927 million, up from US$3,035 million a month earlier, indicating a monthly surplus.
Although a balance of payments surplus implies an increase in central bank foreign exchange reserves, the repayment of reserve liabilities may keep gross reserves unchanged.
An indexed central bank (intermediate regime) which applies an inflationary policy either by simply injecting liquidity to keep rates low, or by filling liquidity shortages after having defended indexation (by using reserves for imports and refinancing of private sector activity) to mistarget rates will trigger currency shortages and a balance of payments deficit.
Sri Lanka’s central bank stopped mistargeting rates around April 2022 and allowed market rates to rise, which helped reduce domestic private credit, generate more money towards the deficit and reduce money printing, causing currency shortages.
Sri Lanka has also increased taxes and utility charges to reduce public sector borrowing.
However, the Reserve Bank of India has granted deferred Asian Clearing Union dollars to Sri Lanka until June to continue creating balance of payments deficits by sterilizing interventions with borrowed money. (Sri Lanka owed the Asian Clearing Union $1.9 billion in June 2022)
However, after India ended ACU deferrals, the central bank lost the ability to manage balance of payments deficits.
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A central bank that pursues a deflationary policy and reverses money printing will accumulate reserves and generate a balance of payments surplus.
In September, net central bank credit to the government declined slightly. However, the reserve currency also declined.
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Sri Lanka now operates at peg around 360 – 370 against the US dollar, intervening both ways with the 3-month rate around 30%.
At least 8 to 10 basis points of the rate may be due to a loophole in a debt restructuring framework when there is uncertainty as to whether domestic debt, which has already reached a high level in a haircut IFR, will suffer a default and a second restructuring, according to some analysts.
Mainstream economists and analysts have previously urged the central bank to let the currency float after a rate hike, as this drives confidence back to a lower corrective interest rate than if a credibility-losing peg continued. (Sri Lanka needs to raise rates, tourism recovery won’t help end currency crisis)
A float consists of isolating the reserve currency from the balance of payments and stopping all intervention (suspending convertibility) in the foreign exchange markets, whether to buy or sell dollars.
Sri Lanka’s float in March failed due to low rates boosting credit and forcing dollar sales (a call bond or strong lateral convertibility pledge) of dollars to the central bank, further pushing the anchor down.
A float restores confidence in the exchange rate and encourages dollar holders to sell, exporters to convert early, and importers to postpone import payments to pre-crisis levels and lower interest rates further. rapidly.
The central bank was a net buyer of foreign currency from commercial banks in September and October, as private credit contracted and imports declined.
Under an International Monetary Fund program, a float is a prior action. The exchange rate is then pegged to collect reserves. IMF money is disbursed after balance of payments recovery and “import reserves” are no longer needed.
An IMF program will impose a net international reserve target where the central bank will pursue a stricter deflationary policy than a currency board to replenish reserves and sell its stock of treasury bills.
When reserves are collected under a deflationary policy (purchases in dollars are sterilized), it is possible to appreciate a currency parity because credit is weak and rates are above the required market rate.
However, due to a belief in (the politics of the basket, the strip, the crawl) peddled by theorists living in more stable single-anchor regime countries, and the lack of a doctrinal foundation in a currency healthy in countries with intermediate regimes, currencies are not allowed to bounce unlike a floating regime, tipping people partially out of poverty into the abyss and triggering social unrest, in one of the post-mercantilist strategies 1931 most ruthless.
In a shocking revelation, a World Bank survey found that only 2% of policymakers surveyed in South Asia knew that currency problems were caused by central banks.
Currency shortages and balance of payments deficits (as defined) are a problem with soft pegs or intermediate regimes. They are absent from floating regimes and hard anchors without key rates where interventions are not sterilized. A central bank is the only agency that can create currency shortages and balance of payments deficits and also the only agency that can stop them.
Under an IMF program, it is not possible to apply a clean floating exchange rate because there is a NIR target. Consequently, it is also not possible to apply an orthodox inflation targeting regime.
Under the IMF program, flexible inflation targeting where liquidity was injected for stimulus purposes, abusing the central bank’s statutory obligation to maintain stability, would be legalized in a new monetary law.
(Colombo/07/11/2022)
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