ECONOMYNEXT – Sri Lanka central bank’s net foreign assets rose to about 310 million US dollars in November 2024, official data show, as it bought foreign exchange outright through deflationary policy and also settled reserve related liabilities.
Net foreign assets climbed from 18.6 billion rupees (about $63mn) in September 2024 to 91 billion rupees in November 2024, central bank data show.
The net foreign assets of Sri Lanka’s central bank slipped into negative around August 2021 as it spent borrowed reserves to pay for imports and offset the interventions through mainly inflationary open market operations to stop market interest rates from balancing credit.
In November Sri Lanka’s gross official reserves, which are made up of the central bank’s gross reserves (including a swap from China) and Treasury balances, were 6.4 billion dollars.
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A central bank with a policy rate that spends reserves, automatically prints money through open market operations re-financing private credit to suppress rates, triggering a typical Latin America style currency crisis.
In the last currency crisis, Sri Lanka used loans from the International Monetary Fund, a special drawing rights allocation and also Asian Clearing Union arrears in the belief that a central bank with policy rate can use reserves for imports.
Some of the reserves were also used to settle government debt.
At the peak, negative net foreign assets worsened to as much as 4.5 billion US dollars in the last quarter of 2022 when deflationary policy started take effect and private credit slowed. It led to record quasi-fiscal losses.
However part of it was reversed as the exchange rate was allowed to appreciate under deflationary policy.
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Over the past two years, the central bank has bought dollars after selling down its Treasury bills to the banking system under deflationary policy under an appropriate interest rate, and repaid both IMF loans and borrowings from the Reserve Bank of India.
In October there was a spike in excess liquidity from open market operations and warnings have been issued that it will lead to reserve losses and a second default if the policy is continued as private credit recovers.
Related Sri Lanka prints Rs100bn through open market operations
Open market operations were invented by the Federal Reserve in the 1920s as it fired an an economic and stock market bubble which ended in the Great Depression. At the time Treasury was running budget surpluses.
Central bank swaps, which also allows a central bank to delay returning to market interest rates, were also invented by the Federal Reserve in the 1960s, eventually helping it bust the Bretton Woods system.
Under a narrowly targeted policy rate (mid-corridor or single policy rate), a central bank could end up injecting excess reserves to the system when private credit picks up allowing banks to trade without deposits, analysts have warned.
There has been a tendency for spurious monetary doctrines devised in the US, to come to Sri Lanka through IMF technical assistance, critics have said. (Colombo/Jan20/2025)
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