Sri Lanka’s gross official reserves dropped to 2,833.5 million US dollars in July 2021, from 4,060 million in June after a billion US dollar bond and some other accounts were repaid in July, official data show.
Sri Lanka has been injecting unprecedented volumes of liquidity into banks as excess rupee reserves triggering a balance of payments deficit under so-called ‘Modern Monetary Theory’ (an extreme form of ‘stimulus’ after cutting taxes in a fiscal ‘stimulus’, triggering a run on reserves and credit downgrades.
The reserves are the lowest since July 2009, when the country had just finished a war and was rebuilding reserves. At the time monetary policy was tight and prevented a monetary meltdown amid the collapse of the Federal Reserve housing bubble.
In 2021 liquidity has also boosted imports, despite controls on items like vehicles, which bring the highest level of taxes, dollar for dollar, hurting tax revenues, triggering more money printing and reserve losses.
Sri Lanka is heavily steeped in Mercantilism and the link between credit, liquidity and monetary instability is not understood.
It is also the practice of Mercantilists to measure forex reserves in terms of imports, through trade bills need not be paid with reserves as long as liquidity is not injected in to commercial banks.
Sri Lanka’s gross forex reserves were 2.6 months of imports measured as the average of past 12 months in June 2020.
Though July import data is not released, but if imports are below the June level of 1.65 billion dollars and reach at least the February level of 1.52 billion dollars reserves are now around 1.8 months of past imports.
With the Peoples Bank of China swap, which can be drawn down and used to pay for Chinese imports, forex resources are about 2.8 months of imports.
State Minister for Money and Capital Market Nivard Cabraal has said that the reserve fall in July would be temporary.
The International Monetary Fund is expected to disburse around 800 million dollars in special drawing rights in August 2020, and the central bank is also negotiating a 250 million US dollar swap with Bangladesh Bank which has been approved in principle subject to a sovereign guarantee.
Central Bank Governor W D Lakshman had said that a 400 million US dollar swap is also expected from India.
However swaps indebt the central bank and analysts had warned that if liquidity is continued to be injected the monetary authority will end with negative foreign assets.
Last week some corrective action was taken in the form of a 05 basis point hike in the 12-month ceiling rate for Treasury bills, through which debt is monetized and liquidity is injected to trigger a run on forex reserves.