Sri Lanka’s external problem is linked to medium and long term solvency requiring debt restructuring and is not a short term liquidity problem that can be solved by swaps, Harsha de Silva, an opposition legislator said.
Sri Lanka’s 2022 sovereign bond, which was issued at 5.75 percent was now trading at 46 percent, and Sri Lanka could no longer to go international markets to borrow, he said.
“That is the confidence the international markets have in us,” he said. “Then how can we go and take a loan from the international market to fulfill our requirements?”
Despite import controls, Sri Lanka’s imports were continuing, with some imports higher than last year, he said.
Foreign reserves were falling. The solution put forward was to get central bank swaps.
“So there is a problem, but the government has analysed this problem as a problem in liquidity,” de Silva said.
“They said that they will solve this problem through a swap of 1.5 b dollars from and another one billion dollar swap from India and another loan of 700 million from China,” he said.
But the problem was not a short term liquidity problem that that could be solved by swaps, he said.
“I see this not as a liquidity problem but as an insolvency problem, whether we can fulfill the medium and long term financial responsibilities of the country,” he said.
There was a gap between reality and the picture painted by government spokesmen, he said.
If solutions are delayed, the blow on the people would be harder, he warned.
“We should restructure our debts, if the government do that then they will be able to find a medium-term solution to this problem,” he said.
Sri Lanka’s gross official reserves were down to 4,557 million US dollars by 2021 was barely enough for about three months of imports at around 1,500 US dollar a month, he said.
“This is a very dangerous situation, generally in economics, we measure the reserves to how many import months is it enough,” de Silva told reporters in Colombo.
Describing reserves in terms of foreign reserves is a yardstick used by some analysts to measure ‘reserve adequacy’.
Before Keynesian interventionism involving ‘flexible’ policy led to frequent currency collapses, the reserve backing of a currency issue – like the gold standard – was a tool to maintain monetary stability and served as a check against central bank excesses.
Pegged central banks do not use foreign reserves to pay for imports for months on end in practice, unless money is steadily printed (liquidity injections made) and there is an ongoing currency crisis where forex sales are sterilized with new liquidity injections.
In a consistent pegged regime, the monetary authority supplies an unlimited amount of foreign exchange to maintain a fixed exchange rate, triggering contraction in reserve money (reduction in bank rupee reserves) and a spike in short term rates, forcing bank credit to be sequenced and rationed at the margin.
Rupee reserves in banks may be used for import generating credit, credit to buy dollars to repay foreign debt, or to buy assets from fleeing foreign investors, any of which will crowd out other credit, as long as no new liquidity injections are made.
Imports and other forex outflows are therefore matched and sequenced to inflows in a consistent peg with no additional injections.
In practice, in a working pegged system with high credibility, forex losses to trigger a reserve money contraction and tighten liquidity may be measured in weeks (or days) rather than months, analysts say.
A forex sale by the monetary authority to maintain a peg will ration credit below the available new deposits and loan repayment inflows in banks. A forex purchase which injects new liquidity will enable credit over and above deposits and loans repayments in to the banking system, matching outflows of forex to inflows through the credit system.
Therefore there is no depreciation and the peg (external anchor) is kept.
In a true floating regime the central bank does not supply a single dollar to the forex market.
Therefore the monetary base and interest rates are unchanged by foreign exchange flows and credit is automatically rationed to the available deposits and loan repayments in the banking system.
A floating regime matches outflows to the inflows by not altering the monetary base for all intents and purposes, because liquidity is trapped within the domestic credit system even if there is an increase in cash use, unless currency is physically exported.
As part of measures during the East Asian crisis – mis-reported in international financial media as ‘exchange controls’ – Bank Negara Malaysia slapped limits on the export of ringgit notes.