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Sri Lanka is not in an immediate BOP crisis: IMF

Sep 18, 2015 20:47 PM GMT+0530 | 0 Comment(s)

  

ECONOMYNEXT - The International Monetary Fund is concerned over the deterioration of Sri Lanka's balance of payments over the past year, but the country is not in an immediate BOP crisis, IMF mission chief to Sri Lanka, Tod Schneider said.

"Objectively they are sitting on three months or more of foreign exchange reserves so right now, I would not say there is an immediate balance of payments crisis going on," Schneider said in Colombo.

"We have concerns obviously because the balance of payments has deteriorated over the past year and it has had a very visible impact on reserves by the foreign exchange interventions by the Central Bank, but that is not an immediate crisis."

Sri Lanka's gross foreign reserves fell to 6.4 billion US dollars in August 2015 down 30 percent from a peak of 9.18 billion dollars, racked up with the help of negative credit which reduced outflows.

But Sri Lanka's foreign reserve started to dwindle as excess liquidity in the banking system was used up in credit which hit the forex market as imports. The process gathered pace with the state salary hikes and revised budget in January.

Analysts warned at the time that the ultra-loose monetary policy with historically low interest rates, tens of billions of liquidity being poured into money markets weekly and deteriorating fiscal policy was a pro-cyclical witch's brew that will land the country in trouble.

The August foreign reserves of 6.4 billion US dollars include a 400 million dollar 6-month swap from the Reserve Bank of India. Another 1.1 billion US dollar swap was drawn down in September.

Pushed up by rising consumption from state handouts and a pick-up in credit, imports rose to 1.633 billion US dollars in June. Reserves amounted to 3.9 months of imports with the swap, and 3.7 months without the swap.

Other analysts however had pointed out that Sri Lanka was firmly on the track of a payments crisis several months earlier. Despite rising credit the Central Bank cut rate in April 2015 and spooked investors in bond markets.

The IMF was hoping in March that falling oil prices would help the balance of payments. However reporters and analysts warned at the time (Sri Lanka has no immediate need for BOP support) that higher state spending would wipe out any benefits as oil prices had been cut.

 

Falling oil prices benefits the BOP only if prices are maintained and the cash is used to settle the loans of utilities and that cash is sterilized permanently.

But if prices are cut, the money is goes to oil consumers to spend, and if credit is strong, even if the money was saved in banks it will eventually hit the BOP in a standard Ricardian equivalence process.

"The increase in consumer spending created by the sharp rise in public wages and salaries has also contributed to a sizeable increase in imports of consumption and other goods—more than offsetting savings from lower oil prices," the IMF mission said in a statement Friday.

"The resulting deterioration in the nonoil trade balance has contributed to persistent downward pressure on central bank foreign exchange reserves during the first eight months of the year."

Sri Lanka's central bank gets into balance of payments crises every few years by trying to target the exchange rate and defending an interest rate at the same time operating a so-called soft-peg to the US dollar, which is impossible in practice.

Schneider said the allowing of the exchange rate to move and reducing interventions earlier this month was a step in the right direction.

A so-called 'float' ends a cycle of peg defence and liquidity injections (sterilized foreign exchange sales). Data showed that interventions were still continuing.

Schneider said it was too early to say whether the float has failed.

Analysts say unless rates are raised domestic credit is slowed it will be difficult to slow imports and generate resource to meet foreign loan repayments.

This month the Central Bank began rejecting bids at weekly Treasury bill auction to defend not just an overnight policy rate but also a 12-month interest rate monetizing debt outright.

Over the past two months the Central Bank had printed 170 billion rupees either to sterilize interventions or monetize debt outright.

To end Sri Lanka's recurring balance of payments crisis or high inflation and currency depreciation economists and analysts have called for the re-establishment of a hard peg or currency board.

(Colombo/Sept18/2015)


 

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