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Stability Path
Mar 30, 2012 (LBO) - Sri Lanka is on track to resume a loan program with the International Monetary Fund next week, with preliminary data showing that action taken to break credit and domestic demand are showing results.
The IMF held back the final two tranches of around 800 million dollars from its 2.5 billion dollar bailout facility given after a 2008/2009 balance of payments crisis shortly before Sri Lanka entered the current balance of payments crisis.
Tranche Track
IMF's resident representative Koshy Mathai confirmed that IMF's board would meet on April 02 to consider a 7th review under the program.
The IMF did not complete the review in September effectively suspending is program asking the central bank not to defend a dollar peg at around 109 rupees. Sri Lanka either had to break the peg or raise interest rates to prevent a balance of payments crisis.
A central bank could defend a peg by unsterilized sales of dollars which triggers an automatic rise in interest rates and halt of runaway credit as currency board do.
But central banks usually engages in sterilized sales of dollars, which involves printing money in large volumes by buying up government Treasury bills to stop interest rates going up going up.
The process known as 'sterilized intervention' causes a steady depreciation of pegs, foreign reserve losses or both. Sri Lanka started having balance of payments trouble after a sterilizing central bank was created in 1950.
Such practices are symptomatic of so-called 'soft-pegs' created under the failed Bretton Woods peg system. The Bretton Woods system collapsed in 1970 after the US Federal Reserve lost more than a quarter of its gold reserves in six months.
The dollar's collapse came from the Vietnam War and President Nixon's 'Great Society' program of populist spending.
Credit Growth
Sri Lanka's high credit growth came partly from a post-war hotel construction, a car buying bubble and large borrowings from state sector energy utilities to cover losses.
The dollar peg came under pressure because interest rates were not allowed to increase to raise more deposits from the domestic economy to match credit and also reduce overall credit demand.
The Central Bank eventually allowed interest rates to go up, and the state also raised energy prices and the rupee peg was also allowed to fall to help kill domestic demand mid February 2012.
If energy prices were not raised, interest rates would have had to go up further and crowd out more private investment and prolonged the crisis, which analysts say could have also triggered a banking crisis.
The peg has which weakened to 120 rupees to the US dollar in the last balance of payments crisis fell to 131 rupee levels by late March, after the central bank allowed the peg to break, but has recovered somewhat in the last few days.
"We have had a stable exchange rate," Central Bank Governor Nivard Cabraal told an investment seminar organized as part of Sri Lanka's Expo 2012 fair Thursday.
"Right now there has been a transition to a new method of determining our exchange rate and we are seeing stability once again."
Yesterday the rupee strengthened to just under 128 to the US dollar, in the spot market.
Reuters, a news agency quoted Cabraal as saying the Central Bank may stop dollar interventions to pay for oil from May 2012.
Liquidity
Analysts say the move would remove the last threat to the peg.
Interventions could continue without a threat to the peg, as long as dollar sales are not sterilized and rupee liquidity from previous dollar purchases is extinguished from the banking system.
Such non-sterilized sales of foreign exchange interventions do not create money and add new purchasing power to de-stabilize the economy and the balance of payments.
Official data shows that the Central Bank had printed up to 259 billion rupees to sterilize interventions of foreign loan settlements up to March 09, triggering imports over and above the money earned from foreign inflows.
By March 30 the Central Bank's Treasury bill stock has come down to 209 billion rupees.
Meanwhile liquidity has been building up from dollar purchases, as credit growth showed signs of slowing allowing rupee proceeds from central bank dollar purchases to remain in the banking system without being instantly loaned out.
Excess liquidity deposited overnight at the Central Bank's repo window was 26 billion rupees on March 29, with at least one term auction also having taken place.
http://lbo.lk/fullstory.php?nid=337498403
Mar 30, 2012 (LBO) - Sri Lanka is on track to resume a loan program with the International Monetary Fund next week, with preliminary data showing that action taken to break credit and domestic demand are showing results.
The IMF held back the final two tranches of around 800 million dollars from its 2.5 billion dollar bailout facility given after a 2008/2009 balance of payments crisis shortly before Sri Lanka entered the current balance of payments crisis.
Tranche Track
IMF's resident representative Koshy Mathai confirmed that IMF's board would meet on April 02 to consider a 7th review under the program.
The IMF did not complete the review in September effectively suspending is program asking the central bank not to defend a dollar peg at around 109 rupees. Sri Lanka either had to break the peg or raise interest rates to prevent a balance of payments crisis.
A central bank could defend a peg by unsterilized sales of dollars which triggers an automatic rise in interest rates and halt of runaway credit as currency board do.
But central banks usually engages in sterilized sales of dollars, which involves printing money in large volumes by buying up government Treasury bills to stop interest rates going up going up.
The process known as 'sterilized intervention' causes a steady depreciation of pegs, foreign reserve losses or both. Sri Lanka started having balance of payments trouble after a sterilizing central bank was created in 1950.
Such practices are symptomatic of so-called 'soft-pegs' created under the failed Bretton Woods peg system. The Bretton Woods system collapsed in 1970 after the US Federal Reserve lost more than a quarter of its gold reserves in six months.
The dollar's collapse came from the Vietnam War and President Nixon's 'Great Society' program of populist spending.
Credit Growth
Sri Lanka's high credit growth came partly from a post-war hotel construction, a car buying bubble and large borrowings from state sector energy utilities to cover losses.
The dollar peg came under pressure because interest rates were not allowed to increase to raise more deposits from the domestic economy to match credit and also reduce overall credit demand.
The Central Bank eventually allowed interest rates to go up, and the state also raised energy prices and the rupee peg was also allowed to fall to help kill domestic demand mid February 2012.
If energy prices were not raised, interest rates would have had to go up further and crowd out more private investment and prolonged the crisis, which analysts say could have also triggered a banking crisis.
The peg has which weakened to 120 rupees to the US dollar in the last balance of payments crisis fell to 131 rupee levels by late March, after the central bank allowed the peg to break, but has recovered somewhat in the last few days.
"We have had a stable exchange rate," Central Bank Governor Nivard Cabraal told an investment seminar organized as part of Sri Lanka's Expo 2012 fair Thursday.
"Right now there has been a transition to a new method of determining our exchange rate and we are seeing stability once again."
Yesterday the rupee strengthened to just under 128 to the US dollar, in the spot market.
Reuters, a news agency quoted Cabraal as saying the Central Bank may stop dollar interventions to pay for oil from May 2012.
Liquidity
Analysts say the move would remove the last threat to the peg.
Interventions could continue without a threat to the peg, as long as dollar sales are not sterilized and rupee liquidity from previous dollar purchases is extinguished from the banking system.
Such non-sterilized sales of foreign exchange interventions do not create money and add new purchasing power to de-stabilize the economy and the balance of payments.
Official data shows that the Central Bank had printed up to 259 billion rupees to sterilize interventions of foreign loan settlements up to March 09, triggering imports over and above the money earned from foreign inflows.
By March 30 the Central Bank's Treasury bill stock has come down to 209 billion rupees.
Meanwhile liquidity has been building up from dollar purchases, as credit growth showed signs of slowing allowing rupee proceeds from central bank dollar purchases to remain in the banking system without being instantly loaned out.
Excess liquidity deposited overnight at the Central Bank's repo window was 26 billion rupees on March 29, with at least one term auction also having taken place.
http://lbo.lk/fullstory.php?nid=337498403
