ECONOMYNEXT – Sri Lanka spent US$664 million to provide “import reserves” in November and December 2021 as the central bank tried to implement a 200 peg to the US dollar while printing oil money to sterilize the same dollar sales at a fixed interest rate of 6.0%.
The central bank bought US$61.7 million in foreign exchange markets where mandatory buy-back rules were imposed, creating money, and spent US$372.35 million on imports in November.
In December, the central bank bought US$71.16 million from banks and spent US$424.7 million to impose a peg at 200 and provide “reserves for imports”.
A pegged central bank trying to implement a fixed interest rate must print money to compensate for such interventions, pumping new rupee reserves into the banking system as dollar sales from reserves suck banking system liquidity reflecting the transfer of real wealth out of the banking system. country.
Such “unsterilized selling” will reduce the ability of banks to extend new credit and reduce the reserve money supply, which will drive up rates and keep the exchange rate fixed.
However, a loosely pegged central bank pumps money back into the banking system to “sterilize” intervention, perpetuating the monetary crisis by keeping interest rates and the reserve currency fixed.
Central bank data showed that 113 billion rupees were printed in November.
Sri Lanka’s foreign exchange reserves fell in November. In December, reserves were bolstered through a swap.
In a remarkable development, mercantilists and some members of the business community last week called on the central bank to continue selling reserves that will keep the exchange rate at 200 to the US dollar and debt default.
The call for reserve sales to enforce the peg came after many businesspeople previously said the 200 to US dollar peg was unrealistic or not market determined. .
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Due to continued liquidity injections at 6.0% and earlier at around 5.2% by placing price controls on treasury auctions, the credibility of the 200 peg to the US dollar has been undermined. lost and people are willing to pay up to 250 rupees to get the print. money out of the country leading to the emergence of parallel markets.
A float will end “reserve sales” for imports and, therefore, end the need to sterilize intervention, restore the interbank spot market, and balance total inflows with outflows.
As long as reserve sales continue, liquidity injections also continue (the central bank sells both dollars and rupees to the banking system) preventing the credit system from adjusting to the outflow of reserves.
However, a float also causes the currency to fall to a lower level.
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Analysts said the mercantilist myth involving sterilized interventions was propagated by John Henry Williams, an advocate of the US dollar as a “key currency” in a post-World War II monetary system and others like Arthur Bloomfield, who found instances where central gold standard banks supposedly engaged in sterilized interventions and lived to tell the tale.
Such ideas have been rejected in East Asian countries like Singapore, which do not have a fixed policy rate.
“..[W]e wanted indicated to scholars, both local and foreign; that what is fashionable in the West is not necessarily good for Singapore,” Singapore’s economic architect and former finance minister, Goh Keng Swee, said in a landmark speech.
“A discerning mind is needed to distinguish peripheral form from fundamental and passing fads from permanent values.”
The whole “sterling zone” of which Sri Lanka was a member until an American money doctor set up a Latin American-style sterilizing central bank was based on this “permanent value”.
The US Fed in 1971, under then-President Arthur Burns, broke a 300-year-old gold standard, sterilizing interventions in 1971, after printing money earlier to target an output gap. (Colombo/January 19, 2021)