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ECONOMYNEXT - Sri Lanka's forex reserves have fallen by 1.4 billion US dollars to 7,180 million dollars by end September 2018, from 8,584.54 billion rupees in August, amid maturing hedging deals and debt repayments and interventions, official data show.
Sri Lanka's central bank had made interventions of 731 million dollars in 2018 Deputy Governor Nandalal Weerasinghe said on October 02 and purchases of 551 million dollars, which seems to indicate net interventions of at least 644 million dollars in September.
Based on changes of liquidity in money markets, which shifted from an excess aggregate balance of 33.14 billion rupees on August 31, to a short of about 128 billion rupees on September 29 close to about a billion US dollars may have been supplied to the market through swaps and interventions during the period.
About 379 million dollars of hedging deals where the central bank had supplied forward cover in 2013 to state run National Savings Bank matured on September 19, leading to steep liquidity shortages on top of interventions.
Liquidity shortages crop up when a central bank sells dollars in the market, pushing rates up and automatically protecting the exchange rate.
However a soft-pegged central bank, unlike a hard-pegged entity, will then print money to stop interest rates from going up, generating further currency pressure and reserve losses in a vicious cycle, when the new money is loaned by banks.
The Central Bank has only grudgingly allowed rates to go towards the policy ceiling of 8.50 percent.
The central bank injected 14 day money at rates as low as 8.25 percent on Friday after buying bills outright also at below market rates earlier in the week.
But it maintained an overnight liquidity short without permanently sterilizing the interventions in the last few weeks in more prudent policy.
A law to stop the central bank from printing long term money below the Sri Lanka Interbank Offered Rate to sterilize interventions would to a significant way to halt stop balance of payments crises in the future, analysts say.
Sri Lanka's monetary instability began in February when the a series of term repo auctions failed, after the central bank ran out of Treasury bills to mop up inflows.
Analysts who had seen similar problems in earlier crises, and urged central bank in December 2018 to start issuing their own securities to at longer term to mop up liquidity and build up reserves. (Sri Lanka's Central Bank should sell own securities in new credit cycle: Bellwether)
In March and April around the time of a so-called 'buffer' strategy to repay bonds, large liquidity injections were made, rates were cut and the rupee was allowed to slide with excess liquidity generating the first run on the rupee.
There had alrady been warning that printing money to pay domestic debt would result in foreign exchange shortages and sovereign debt default. (Sri Lanka's Weimar Republic factor is inviting dollar sovereign default: Bellwether)
In August there was another massive unsterilized liquidity spike, again the rupee was allowed to slide with excess liquidity. In that liquidity spike and run that came in its wake, short term foreing exchange swaps, of the style used by international speculators to hit at central banks had also been used to generate rupees and push up excess liquidity.
The rupee has so far fallen to 170 to the US dollar. The central bank is also targeting a real effective exchange rate index. A REER peg involves importing the monetary policy of the worst central banks in the region, critics say.
The central bank has since made the finance ministry slap import controls, undermining the credibility of the administration and its core free trade agenda. Analysts had warned earlier that the central bank had to be restrained for free trade to succeed. (Sri Lanka central bank has to be restrained for free trade to succeed: Bellwether)
The money printing central bank set up in 1950 led to progressive exchange and trade controls, and helped economic nationalists and import substitution artists to ask for protection. (Colombo/Oct06/2018)