ECONOMYNEXT – Overnight money markets in Sri Lanka have dried up due to rising counterparty risk, adversarial monetary and exchange rate policy continues and authorities fail to establish a functional exchange rate or floating in the middle of interventions.

Although policy rates were raised, the central bank continued to print money to accommodate various activities, with its stock of treasury bills representing permanently injected money reaching 2.269 trillion rupees against 2.234 billion the previous week.

Commercial banks that provided loans without deposits are borrowing an additional Rs.766 billion overnight from the central bank, while more conservative and more conservative banks have deposited Rs.315 billion with the monetary authority instead of lending on the interbank market.

Cash plus banks are reluctant to lend to banks that face cash shortages. Many banks facing rupee liquidity shortages are also facing dollar liquidity shortages.

The central bank has no limit per individual bank to restrict central bank credit. There have been calls to tame domestic central bank operations with strict limits.

Sri Lanka has a Latin American-style central bank where reserve sales are systematically sterilized to maintain an artificial policy rate leading to a balance of payments deficit.

Latin American-style sterilizing central banks were put in place, rejecting basic classical monetary peg theory, including those of David Ricardo and David Hume, and giving tools to state bureaucrats to destroy currency healthy to keep interest rates low.

The central bank attempted to float the currency to end contradictions in monetary and exchange rate policy (suspend convertibility), but the attempt failed amid a repurchase obligation and the rupee fell from 200 to 360 for the US dollar.

Overnight call market lending by plus banks to overdrawn banks, which stood at around Rs 50-60 billion when the float started, has now fallen to around zero.

The central bank has run out of foreign exchange reserves to intervene in the foreign exchange markets and is borrowing dollars from India to continue intervening and financing imports, which analysts say is causing loan to loan ratios to deteriorate. central bank deposits when sterilized by liquidity injections.

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Sri Lanka continues to finance its imports monetarily, securing itself after having “exhausted” its reserves

Foreign banks are among the cash plus banks. Cash and banks have little or no risk limits on counterparties, making it difficult for them to trade, according to market participants.

Sri Lanka’s central bank launched aggressive open market operations after the end of a civil war and escalated after the third quarter of 2014 in a bid to keep interest rates artificially low as credit The domestic economy was recovering in the post-civil war period, resulting in three exchange rates. crisis is seven years, large foreign borrowings and ultimately defaults.

Most Latin American-style sterilizing central banks trigger sovereign debt defaults repeatedly after printing money to suppress rates despite deficits and national debt lower than Sri Lanka’s.

Sri Lanka follows the failed policies of Robert Triffin-Raul Prebisch (sterilization of the central bank), John H Williams (key currency defender/rejection of Hume, flow of cash), John Williamson (basket, band, creeping depreciation ).

Similar policies (with the exception of the BBC/RRSP targeting policy which were not adopted by the Fed or the Bank of England) led the United States and the United Kingdom to serious monetary difficulties and to political unrest until 1980, critics said.

In a currency bill, the Williamson-style BBC/RRSP targeting policy should be legitimized by a reserve collecting a soft anchor called a flexible exchange rate (a permanently depreciating non-floating exchange rate regime).

When the United States tightened its policy from the 1980s, the economies of the countries in which central banks were created or issuing departments were made more aggressive thanks to the Prebisch-Triffin reforms collapsed and made lacking like Sri Lanka.

In Sri Lanka, a Latin American-style central bank was created by a specialist in American money, giving economists the possibility of engaging in the monetary financing of imports and deficits and of triggering monetary crises from from 1950.

Persistent currency crises and high rates due to failure to establish a float or re-anchor where credibility is restored, then lead to banking crises.

The drying up in call markets represents risk perceptions at the level of institutional lenders that have yet to penetrate the mainstream, showing that there is still a window to restore a credible monetary regime, analysts say. (Colombo/July 20, 2022)