Is Sri Lanka’s exchange rate gamble likely to be repeated, ask economists

Sept 21 2009 (LBO) – Will Sri Lanka’s latest balance of payments crisis, triggered by an unstable peg be a lesson for the future, or was it a gamble which was barely won but is doomed to be repeated again, economists at a conference in Colombo asked. Sri Lanka tried to defend a dollar peg when capital flowed out of the country in late 2008, and simultaneously injected rupees into the system to fill liquidity shortages (printing money), a process known as sterilized intervention.

The country lost more than two billion US dollars and dollar backing for the monetary base fell by more than 60 percent, until the rupee was floated in late March ahead of an International Monetary Fund bailout, restoring the credibility of the peg.

Nothing Learned?

Amal Sanderatne, head of Frontier Research, a consultancy, told the annual sessions of the Sri Lanka Association of Economists (SLEA) that the country defended a dollar peg around 108 and finally by “allowing the exchange rate to float” a “crisis” was avoided.

Sri Lanka has now again been hit by hedge fund carry trades with interest rates higher than most other countries due to deficit spending, credibility of the peg restored after the float, and an IMF deal in place.

“And the que