ECONOMYNEXT – Foreign exchange liabilities of Sri Lanka’s central bank has exceeded its reserve assets by 662 billion rupees (US$3.29bn) in January 2022, up from 386 billion rupees (US$1.9bn) a month earlier as it got deeper into debt to repay debt and provide reserves for imports, official data show.
In January 2021 Sri Lanka’s gross official reserves, which includes fiscal reserves if there are any, fell to 2,361 million dollars from 3,139 million dollars.
The central bank stands to make large quasi-fiscal losses as soon as the rupee falls raising questions about its ability to conduct monetary policy.
There have been warnings that the central bank could lose control of reserve money and the country could end up in full dollarization like in several Latin American nations.
Though various claims are made, a central bank only has control over one variable – reserve money or the monetary base.
The International Monetary Fund has also warned that the central bank may lose control of money and the economy could implode unless money printing is stopped.
“Unless the fiscal and balance-of-payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits,” an IMF statement said after annual consultations.
The IMF said Sri Lanka’s public debt including of central bank liabilities had risen to 119 percent of gross domestic product.
The central bank has about 1.2 billion dollars of loans due to the IMF from previous currency crises.
Sri Lanka usually has a negative balance to the Asian Clearing Union as well.
The central bank has also given reserves for imports as money printing created forex shortages and sterilized them at 6.5 percent adding more rupee reserves into the banking system.
Reserve money is continuing to grow despite reserve sales for imports to maintain the 200 to the US dollar peg and inflation has hit the highest since 2008.
The central bank has been following highly discretionary inflationary policy from around the third quarter of 2014, leading to a series of currency crisis from so-called stop go policies (printing money and hitting the breaks when the balance of payments fell apar).
From after 2015 deadly call money rate targeting was started (printing large volumes of money to generate excess liquidity and short term rates from hitting the policy ceiling) as soon as credit picked up from the last currency crisis, as well as REER targeting (depreciating the currency to cut real wages and give zero-sum profits to export firms) and output gap targeting (printing money to boost growth).
The IMF gave technical support to Sri Lanka’s trigger happy central bank to calculate the ‘output gap’ which will be used as a tool to print money under so-called data driven monetary policy despite operating a reserve collecting peg, triggering balance of payments deficit.
As inflationary policy triggered forex shortages making it difficult to repay maturing dollar debt as Asset Liability Management Law to borrow more dollars. The CPC which also ran short of dollars as the central bank printed money, borrowed more dollars through suppliers credit.
In 2020 output gap targeting turned into what was termed Modern Monetary Theory as extreme form of ‘go policy’ with reserve ratios and rate cut even as budget deficits ballooned with tax cuts in a bid to create a ‘production economy’, blowing the balance of payments apart.
Analysts warned that the monetary policies were similar to those of German Social Democrats during Weimar Republic and dollar debt default will be the result.
Like the CPC and the central government, the central bank also borrowed dollars mainly through swaps as liquidity injections created for shortages. In 2021 it also got a special drawing rights tranche from the IMF.
After MMT ‘go’ policy the central bank is now trying to hit the brakes, with policy rates hiked 100 bp last week to 750 percent. But money is still being printed to sterilize interventions and also give subsidies to expat workers who remit money through the banking system. (Colombo/Mar08/2022)