Sri Lanka monitors exchange rate, appropriate current level: BC Governor

ECONOMYNEXT – Sri Lanka’s central bank may make changes to the exchange rate in the future if necessary, but the current level is appropriate, Central Bank Governor Nivard Cabraal said amid calls to float the currency and to stop reserve sales for imports.

The Sri Lankan rupee is pegged to the US dollar at 200 rupees, but the central bank does not allow short-term rates to rise and reserve money to contract after selling reserves to maintain the exchange rate.

Instead, it prints money to maintain the policy rate, triggering cascading credit through the banking system (including the purchase of treasury bills with printed money), more consumption, and more debt. ‘imports.

Until March 03, money was printed at 6.5% to sterilize interventions. On March 5, the rate was raised to 7.5%. A currency peg with a fixed policy rate (also called a soft peg) collapses when economic activity or the budget deficit stimulates domestic credit.

“The Monetary Council (the agency’s board) is of the opinion that the exchange rate at the current level is appropriate,” Governor Cabraal told reporters after raising the key rate.

“If in the future changes need to be made, we can do so. But for now, we think the level is appropriate.

He was responding to a question about growing suggestions to float the rupee as currency shortages disrupted energy imports.

A float or suspension of convertibility prevents the central bank from giving out dollars for imports or other purposes, simultaneously stopping the injections of money made to maintain the policy rate.

Breaking sterilized intervention limits dollar outflows to dollar inflows, keeping individual banks’ rupee reserves unchanged.

However, a float usually leads to a depreciation, which can be strong when the injection of liquidity to enforce low rates has triggered wide parallel exchange rates.

Depreciation drives up inflation and also destroys real savings available for investment or debt repayment, the retirement savings of the elderly, generates a need to raise energy prices.

Countries that depreciate currencies, engage in energy subsidies, accumulate circular debt in electricity and electric utilities, endlessly raise energy prices and social unrest.

“All policy decisions bring multiple outcomes,” Cabraal said. “Some people bring the proposal (floating the rupee) when this is implemented, pressures from different directions will emerge.

“When the Monetary Council takes a decision, it is done after an in-depth study.

“At the moment, the decision of the Monetary Board is that such a thing should not be done. So we are acting accordingly. We are monitoring the situation. We also know what needs to happen.

“Sometimes when we don’t make decisions at a certain time, some parties may have different opinions, but as the Monetary Council, we make a decision after a long discussion.”

Analysts and economists have called for changes to the law governing the central bank to prevent the Monetary Board from printing money to manipulate short-term rates in the first place, create parallel exchange rates and currency shortages.

Since Cabraal took office in September, he has allowed Treasury bond rates to rise to prevent direct financing of the deficit, but gave reserves for imports from October and sterilized interventions with cash. costs.

That a central bank could sterilize interventions was an idea that came to mind among others by Princeton economist John H Williams after World War II during the establishment of the failed Bretton Woods system of soft-pegs going to the counter to two centuries of classical economic teachings, the analysts mentioned.

That countries should depreciate currencies for trade benefits (mercantilism), creating social unrest although the resulting inflation, permanently high interest rates and current was propagated among others by John Williamson, who was influential at the International Monetary Fund at the time.

By his own testimony, he was fiercely opposed by others, including John Marcus Fleming at the IMF, one of the two classical economists who originated the Mundel-Fleming model, which explained why mercantilism was taught at the Cambridge University, Harvard and elsewhere after the Great Depression which had destroyed countries and created social networks. troubles by the collapse of the currency.

If money were printed to keep rates low to stimulate growth under Keynesianism (IS/LM), there would be a balance of payments deficit (ISLM-BOP) and the currency would be under pressure.

Founding Minister of Finance and Governor of the Central Bank of Singapore, Goh Keng Swee, said such false beliefs would soon make a nation a “miserable developing country”.

Latin America was the biggest victim of these central banks where money printing (usually to sterilize interventions) led to sovereign default, especially after the Bretton Woods collapse. When money is printed to keep rates low, not only are there not enough dollars to pay for imports, which are rising, but countries are also unable to repay foreign debt. (Colombo/March 5, 2022)

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