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ECONOMYNEXT – Sri Lanka’s cabinet of minsters had approved a draft for a new monetary law that will govern the country’s Central Bank, a government statement said.

The passage of the bill by Cabinet is one of the prior actions for the Executive Board of the International Monetary Fund to approve a loan and reform program for Sri Lanka.

Sri Lanka operates a soft-peg or intermediate regime which is prone to currency crises whenever the monetary authority prints money (injects liquidity) to suppress interest rates.

The new law is expected to stop the central bank from directly purchasing Treasury bills from auctions, giving so-called provisional advances (zero-interest printed money) for the budget.

It will also formalize the flexible inflation targeting, a regime which falls short of true inflation targeting, for which a clean floating exchange rate regime is required.

Sri Lanka is expected to operate a flexible exchange rate (yet another intermediate regime) which critics say was responsible for recent serial currency crises, forex shortages, so-called ‘cover up borrowings’ and eventual default.

Sri Lanka has gone to the IMF 16 times after getting into external crises by operating intermediate regimes.

Typically is money is printed to monetize maturing debt and suppress rates, effectively re-financing private sector credit, which is then blamed on deficits, critics have said. In Latin America external crises are typically triggered by failure to roll-over sterilization securities.

The central bank in 2018 created a currency crisis almost entirely with open market operations, injecting money through term, overnight and outright purchase of bills to target the yeild curve.

Sri Lanka’s economic bureaucrats have operated intermediate regimes since August 1950 leading to progressive exchange controls and trade restrictions, currency depreciation, inflation and social unrest. (Colombo/Dec20/2022)

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