Sri Lanka’s central bank largely loses ability to create BOP deficits

ECONOMYNEXT – Sri Lanka’s central bank is gradually losing its ability to create balance of payments, deficits data how, after running out reserves and counterparties and foreign central banks no longer willing to loan foreign currency, data show.

Balance of payments deficits are problem associated with soft-pegged central banks which prints money to drive up credit and sells dollars to stop the currency falling when its peg comes under pressure from the newly minted cash.

In the latter stages of a balance of payments crisis when private or state credit picks up, a central bank will intervene and print money to control rates (sterilize the intervention).

Sri Lanka’s central bank ran out of reserves (some of which were borrowed) in April 2022, but was able to continue to intervene with money loaned by the Reserve Bank of India through delayed Asian Clearing Union money.

Sri Lanka’s central bank created the biggest BOP deficits in its history after printing money from 2020 to target an output gap after cutting taxes in the style of UK’s Barber Boom or Prime Minister Liz Trusts stimulus attempts (now abandoned in apparently new found wisdom).

Money printing was taught as macro-economics (John Law garnished with statistical functions) in most UK and US universities after the 1930s with the notable exceptions of London School of Economics and University of Chicago.

Sri Lanka’s central bank created a BOP deficit of 2.3 billion US dollars in 2020, 3.6 billion US dollars in 2021 and 2,986 million US dollars up to July 2022. Up to August the BOP deficit was officially calculated as 3,035 million US dollars.

After creating expanding the BOP deficit by 219 million US dollars in June, and 172 million in July, a 49 million US dollar BOP deficit (as calculated by the central bank) was created in August.

A BOP deficit roughly corresponds to a fall in net international reserves. The BOP deficits from January 2020 to August 2023 totaled 9.3 billion US dollars.

By December 2019 Sri Lanka gross official reserves 7.6 billion US dollars (which includes fiscal balances) but the central bank managed to bust up over 9.3 billion US dollars by borrowing from other central banks through swaps.

The RBI and Bank of Bangladesh had loaned money through swaps for the central bank to intervene and print money to mis-target rates after the intervention.

China fortunately did not allow its swaps to be used for interventions and subsequently mis-target rates by printing money.

Currency crises hit countries where policy makers apparently do not know the difference between a sterilized and unsterilized intervention and there is also no strong doctrinal foundation in classical economics or sound money.

A World Bank survey found that only 2 percent of experts surveyed in the region pointed to monetary policy for monetary instability. (Sri Lanka, South Asia currency crises, World Bank survey in shock revelation.)

Soft-pegs usually float after running out of reserves.

Unlike a soft-pegged central bank (a monetary authority with a flexible exchange rate) a floating exchange rate central bank will not create BOP deficits or forex shortages as it does not intervene in the forex market to give reserves for imports.

Soft-pegs with fixed policy rates were cooked up by US Mercantilists (the policy rate was also accidentally discovered by the Fed in the process of creating roaring 20s bubble which led to the great depression – Sri Lanka, world’s poor suffers from Fed’s accidental discovery) who built the Bretton Woods system of failed pegs.

A central bank which runs out of reserves can still depreciate the currency by printing money, though it large loses the ability create BOP deficits.

Mercantilists have cooked up a regime called flexible inflation targeting where floating rate style open market operations are used to bombard a peg until it collapses and then the policy error is compensated by depreciation.

Soft-pegs that create BOP deficit loses the ability not only to pay for imports (convert domestic currency to US dollars) but also settle debt leading to a borrowing spree which is called ‘bringing finance’ in Sri Lanka.

Singapore’s ex-Prime Minister Lee Kwan Yew called such loans ‘cover up loans’ in the process of explaining the people why the country decided to make unsterilized interventions and not have a policy rate. (Colombo/Oct21/2022)