ECONOMYNEXT – Sri Lanka has spent 967 million US dollars to give ‘reserves for imports’ in the past four months and strictly enforce a 200 to the US dollar peg on which credibility has been lost, official data shows.

In a functioning monetary regime, a pegged central bank does not give any ‘reserves for imports’ but collects a small amount of dollars from monthly inflows at a market interest rate by slowing credit and outflows to re-build or maintain reserves after repaying debt.

In the nine months to September the central bank bought about 228 million dollars net from transactions with commercial banks though total reserves continued to go down at the interest rates and domestic credit levels then prevailing due to debt repayments.

A substantial volume of foreign exchange was also ‘floating’ unofficially at the time with exporters giving dollars at round 220 to the US dollar by transferring to accounts of importers with a non-credible peg at 200 to the US dollar being declared.

Such sales do not change reserve money or require new money to be printed.

However with banks given strict instructions not to facilitate such deals, the central bank had to give more ‘reserves for imports’.

From October to January the central bank had given 967 million US dollars on a net basis to commercial banks in ‘reserves for import’.

Selling reserves for imports is a defence of the peg at 200 to the US dollar.

However when a central bank sells dollars to the market, reserve money shrinks. The central bank then has to print money to stop short term interest rates from going up.

The newly printing money then gives more rupee reserves for banks to give loans without deposits to customers and imports continue to go up.

By December monthly imports rose to 2.2 billion US dollars from 1.6 to 1.7 billion US dollars in earlier months.

From October to December the central bank 736 million dollars on a net basis to banks.

In the same period 262 billion rupees were printed. Monetary base also rose about 20 billion rupees.

The central bank is now printing money to offset or sterilize such reserve sales and also to give a subsidy to expat workers who are remitting money.

In an extraordinary development, there were calls made in Sri Lanka pressure the central bank to use ‘reserves for imports’, which analysts say is a call to printing money and worsen a sterilized intervention cycle.

In order to get out of a currency crisis the cycle of giving ‘reserves for imports’ has to be halted, usually through a float at a market interest rate.

Sri Lanka’s pegged exchange rate is currently broken and reserves. The peg is also under pressure from surrender requirement.

In January the central bank sold 407 million US dollars to the market and bought 176.8 million US dollars from banks.

Such reserve sales were last seen in the 2018 currency crisis. All of Sri Lanka’s past currency crises have intensified. (Colombo/Feb15/2022)