Sri Lanka central bank sells $467mn in August

ECONOMYNEXT – Sri Lanka’s central bank sold 467 million US dollars to commercial banks in August 2023 and bought 296.5 million US dollars indicating net sales of 170.5 million US dollars in the month, official data shows.

August is the third month transactions with banks were negative. The data does not included official transactions.

In June net interventions were 13.5 million negative and in July net interventions were 12.5 million negative.

Interventions started to become negative with the full deployment of an International Monetary Fund backed confidence busting ‘flexible exchange rate’ an hoc peg arrangement which spreads panic among market participants.

From around June the confidence shown by foreign investors in rupee bonds also waned as the flexible exchange rate took effect.

The flexible exchange is neither a hard peg nor a clean float, and is now found in countries with the most severe monetary instability.

The flexible exchange rate, critics say is a device to compensate by devaluation all monetary policy errors made in mis-targeting a policy rate through inflationary open market operations.

In order to keep an exchange rate stable and resrefves nuetral domestic interest rates have to be sufficiently high to avoided inflationary open market operations (reserve repo injections).

In order to collect reserves, domestic interest rates have to be sufficiently high to allow deflationary open market operations.

A collection of foreign reserves from current inflows (i.e de facto financing of the US deficit) requires a moderation of domestic investment from domestic savings of equal value.

Sri Lanka’s IMF programs usually fail in the second year because rates are cut claiming inflation is low, just as private domestic credit also recovers. IMF programs are also flawed analysts say as fx targets clash directly with the inflation target (monetary policy consultation clause).

As a result the reserve target is missed (due to liquidity injections made to supress rates0 without missing the inflation target. The falling currency then discredits and incumbent administration as food and energy princes go up, leading to the abandonment of reforms.

The central bank will usually inject money to mis-target the call money rate, regardless of whether budget deficits expands due to spending (2016) or budget deficits are cut with taxes (2018) as private credit picks up and the economy recovers.

The stabilization measures that follow will slow the economy and expands the deficit and debt.

In either case politicians and the general public will get the blame as operational frameworks of runaway note-issue banking is a mystery to the public. Legislators in countries with monetary instability necessarily do not have enough knowledge about note-issue banking to counter the charges.

Analysts have raised concerns about overselling central bank’s Treasury bill stock by large margins, and then injecting money overnight or longer term, forcing banks and primary dealers to get addicted to reserve repo money.

Any sell-downs of central bank held Treasury bill should be a reasonable volume that can be covered by liquidity from dollar purchases of the central bank before the next Treasury bill auction.

Reverse repo injections to pad up rupee reserves of aggressive banks and encourage mis-lending (buy g-secs) without real deposits began in the last week of May 2023.

The new monetary law has no restrictions on this type of action.

In August, some banks also had to cover their exposures after the repayment of government dollar debt in rupees as part of the re-structuring process, which banks in turn had to cover their exposure.

On August 16 the central bank also cut the statutory reserve ratio, releasing large volumes of liquidity, which some banks could have used to finance the state or other lenders, or cover their short positions.

Western countries at peace started to run balance of payments deficits after the 1920.

BOP deficits and inflation worsened after World War II when nationalized central banks, now run by academically qualified inflationists in the Cambridge-Saltwater tradition, rejected two centuries of classical banking practices and started to rely on econometrics.

From 1980 depreciation worsened as the IMF stopped supporting exchange rate stability (the agency was set up originally for that purpose), triggering previously unseen monetary instability, mass social unrest and default in market access countries.

Currency collapses that triggered commissions of inquiry before World War II, were peddled as routine by inflationists after 1980 dooming the countries into permanent monetary instability. (Colombo/Sept19/2023)