ECONOMYNEXT – Sri Lanka has posted a 130 million US dollar surplus in the external current account in January 2025, compared to an 81 million US dollar surplus central bank provisional data showed.
Sri Lanka’s central bank, which started to give data beyond import and exports and the trade deficit (a measure used in classical mercantilism) has now started to give the entire current account.
The current account became the focus of neo-Mercantilists in the last century.
A current account surplus indicates an outflow in the financial account, to repay debt on a net basis or to build foreign reserves.
In order for a country with a bank of issue to be able to repay debt, interest rates have to be compatible with financial account requirements.
Any rate cuts which are incompatible with debt repayments needs will lead to rising domestic credit and the inability to repay debt.
The mis-targeted rates will then lead to a run-down of foreign reserves as the current account surplus narrows and then disappears altogether.
According to central bank data foreign reserves (gross) fell by 56 million US dollars in January 2025.
Analysts had warned in October that the central bank was printing large volumes of money to suppress rates in the pursuit of a single policy rate, undermining the workings of the interbank money market, counter-party risks.
A single policy rate also promotes moral hazard and rewards overtrading banks and if excess liquidity is supplied continuously leads to an expansion of private credit unrelated to deposit of banks and an overall balance of payments deficit, analysts have warned.
The overall balance of payments deficit is a concept related to net reserves.
A run down of (gross) foreign reserves of one or even two months, particularly in fiscal reserves is usually not a problem as it may not be possible to accurately match official payments to the current account on a monthly basis.
However, a steady run down of reserves indicates that interest rates are out of line with the debt repayment needs and domestic private credit is expanding too fast.
The imbalance takes place due to the bureaucratic policy rate of a monopoly central bank with inflationary open market operations. A steady run down of the central bank net reserves is indicative of monetary instability and incompatible rates.
Sri Lanka’s central bank also has reserve related liabilities it has to settle. The loans were taken to suppress rates and trigger an external crisis and default.
The external current account can go into deficit due to inflows in the financial account, such as through net foreign borrowings of the government for project financing or private banks borrowing abroad or foreign direct investments.
Any or all of such funds, invested domestically can trigger imports of capital or intermediate goods widen the trade deficit and trigger a current account deficit, without endangering monetary stability or undermining confidence in the currency or triggering market panic.
The current account is a mirror image of the financial account subject to errors and omissions.
In Sri Lanka under IMF advice interest rates are determined by flexible inflation targeting (data driven monetary policy), a regime found in defaulting countries where the bureaucratic interest rate of a reserve collecting central bank is cut claiming that historical inflation in the past 12 months is low.
Foreign reserves can be run down either due actual money printing involving changes in reserve money, which triggers interventions in the forex market, or the inability to collect reserves and settle reserve related liabilities of the central or fiscal repayments due to ‘signalling’ rates down.
In Sri Lanka the government does not have its own foreign exchange trading desk and is dependent on central bank sterilizing reserves by altering reserve money.
Before the invention of the policy rate in the 1930s and inflationary open market operations, there was no problem in the government depending on the central bank to settle its foreign liabilities.
In the absence of a policy rate, any government cash surpluses earmarked for foreign repayments that are deposited in the central bank automatically leads to an increase in foreign reserves by curtailing domestic credit.
(Colombo/Mar03/2025)
