Dec 05, 2011 (LBO) – Sri Lanka’s non-bank finance companies should borrow abroad to increase resources they have to lend to the domestic economy, Central Bank Governor Nivard Cabraal said. In the 1980s amid high deficit spending and loose monetary policy, the currency was continuously depreciated to avoid balance of payments crises.
When foreign currency deposits are allowed it lead a build-up of forex holdings, a phenomenon known as deposit dollarization.
When the management of a soft-peg to improve a little and there is a period of exchange rate stability, domestic participants may be incentivized to borrow abroad due to interest rate differentials.
The phenomenon known as ‘liability dollarization’ can result in large losses to borrowers when a soft-peg eventually breaks. A soft-peg breaks either because of outright deficit financing of the state by central bank credit or due to delays in allowing rates to move up.
But if exporters in particular, who have access to forex revenues can be encouraged to borrow in foreign currency, it could help temper continuous calls to depreciate the currency.
Classical economists have said