ECONOMYNEXT – Sri Lanka bought US$76.6 million in May 2022 and sold US$155.1 million, continuing to intervene on both sides of a loose or flexible exchange rate three months after an attempted float currency, according to official data.

The central bank bought US$150.9 million from commercial banks in April 2020, through a repurchase obligation, despite pressure on the currency and sold US$244 million, providing convertibility at a given pegged exchange rate.

In March, an attempt was made to float the currency, which requires a complete suspension of convertibility to end currency shortages.

Currency shortages persist when a central bank with a policy rate intervenes for imports, as liquidity is pumped back into the banking system after intervention in a sterilized currency sale.

After completely depleting its reserves, the central bank steps in with returned dollars and deferred payments to India under the Asian Clearing Union.

In April, the central bank recorded a balance of payments deficit of US$2.56 billion, compared to US$2.26 billion in March with borrowed reserves.

The buy-back rule, in addition to pushing the peg down, changes the rupee reserves in the banking system.

Currency buybacks at the central bank and subsequent sterilized sales with overnight cash tend to increase asset-liability mismatches in banks financing loss-making state enterprises and oil bills, while by creating excess liquidity in banks that do not carry out excessive transactions.

However, redemptions had declined in May compared to the number in April.

Central bank interventions for imports (private credit financing) with UCA dollars tend to increase the central bank’s debt or negative net foreign asset position, while causing a deficit in the balance of foreign assets. payments.

A currency is usually floated to end currency shortages and balance of payments deficits after a loosely pegged central bank has exhausted its reserves to restore monetary instability with a complete suspension of convertibility (exchanging dollars against rupees).

A float is usually achieved at a lower overall interest rate level than by breaking the credit to re-establish a non-floating peg.

Analysts had warned of timid floating, which tends to happen in Third World central banks and those in Latin America due to the so-called “fear of floating”.

“..[A]Any type of half-hearted treasury bill and bond auctions, partly failed bond or bond auctions with certain volumes of printed money will lead to progressively higher interest rates, but the losses of reserves and the depreciation of the currency will continue,” warned EN’s economic columnist. (Sri Lanka’s monetary collapse will accelerate unless swift action is taken)

“Soft-peggers are not good at floating. Partial interventions (flexible exchange rate) will lead to even higher interest rates and further loss of confidence.

“In Argentina, short-term rates have increased by up to 60% due to the ‘flexible exchange rate’ (which is neither floating nor pegged) that has caused so much damage to Sri Lanka since 2015, coupled with a unsterilized disorderly market conditions (DMC) rule, which also lacks credibility.

“High interest rates can kill many businesses. High partial float rates can kill finance companies and banks.

“When dying banks are bailed out with printed money, it is usually even more difficult to control the exchange rate.

“Inflation and cash shortages will lead to a collapse in consumption which will also destroy businesses. Low reserves will lead to default on foreign debt, as happened for the Weimar Republic.