In Sri Lanka’s balance of payments crisis before 2018 had been caused by rock-steady Treasury bill yields targeted with printed money, observers who track policy errors of the central bank say.
The 2018 crisis was triggered by using excess liquidity through term and overnight cash injections to target the call money rate as well as currency swaps of the type used by speculators to hit East Asian central banks.
Since the latest bout of money printing began, the rupee fell from 182 to around 200 to the US dollar and had been brought closer to 190 by selling dollars.
Changyong Rhee, Asia Pacific Director of the International Monetary Fund said any country with a non-internationalized currency (a soft or unstable peg) will have to be prepared for foreign exchange trouble and may have to use exchange controls (capital flow measures).
“So, when they actually rely on large stimulus packages, they have to worry about its possible negative impact on their external sector especially the FX market,” Rhee said.
Sri Lanka has tightened exchange controls, halted trading in the stock market preventing foreign investors from selling out and also slapped import controls. Minister has told the public to grow kollu (horsegram).
Due to classical economic illiteracy, many in Sri Lanka honestly believe that currency troubles do not come from liquidity injections and monetary policy incompatible with maintaining a peg, but from imports.
Sri Lanka which was already hit by a ‘fiscal stimulus’ in January 2020 in the form of a value-added tax cut, the monetary stimulus had earned a credit downgrade and the foreign exchange shortage coming from liquidity injections had made it more difficult to repay foreign loans and re-finance bonds as jittery investors sold dollar bonds.
In the current balance of payments crisis, the central bank injected liquidity through blatant money printing (buying bills outright with printed money) as well as via term and overnight reverse repo auctions, reserve ratio cuts, and a central bank profit transfer.
The helicopter drops of monetary stimulus came on top of tax cuts in January.
However at least 140 billion rupees was injected during March to satisfy a cash drawdown from the banking system as people held more money for the curfew, which would not hit the currency.
The central bank’s Treasury bill stock grew to 298 billion rupees on April 30 from 69 billion rupees on February 19. When liquidity is injected, dollars have to be sold from reserves to stop the rupee from falling.
On April 20, excess liquidity dropped to 137 billion rupees from 164 billion rupees a day earlier. On April 30, a 13 billion rupees term reverse repo deal (previously injected money) matured killing some excess liquidity.
Excess liquidity can drop also due to cash drawdowns and forex reserve sales to stop the rupee from collapsing further.