July 4, 2009 (LBO) – Sri Lanka’s central bank has bought 290 million US dollars from forex markets in June to boost its foreign reserves, bringing the total purchases since a float of its currency in March to 450 million US dollars. The vicious cycle quickly gathers pace, and uncertainty about the currency results in fresh flights of capital and exporters also hold back dollars.
“The central bank eventually loses so many foreign reserves it either must finally reduce the monetary base or it must abandon the pegged exchange rate and go to a floating rate,” according to Kurt Schuler, an international expert on currency regimes.
A pegged central bank is most gung-ho about its ability to hold the exchange rate when it has the most foreign reserves and floats the currency when reserves hit rock bottom.
In March when Sri Lanka floated, net foreign reserves backing the local monetary base had fallen to 830 million dollars, from a peak of three billion dollars in September.
According to Central Bank data, it has bought 37.25 million US dollars in April, 123 million in May and 290 million in June.
Officials have said the performance of the monetary authority has exceeded the quantity targets discussed with the IMF in March.
Sri Lanka’s gross reserves are now estimated to top 1.5 billion US dollars.
Error corrected – June purchases 290 million US dollars The Central Bank floated the rupee in March as a prior action for an International Monetary Fund loan of 1.9 billion US dollars.
The float ended a period of dollar peg defence that created a balance of payments crisis and cost the country more the 2.0 billion dollars in foreign reserves.
The IMF loan has been delayed amid political wrangling by the United States and Britain as relations between Sri Lanka and the West took a dramatic downturn in the last stages of fighting with Tamil Tigers separatists.
But Governor Cabraal said last week that the loan was no longer urgent.
“Let it come at the time it comes,” Cabraal told a business forum in Colombo. “Till it comes let us managed it (exchange rate) as it is being managed.”
The rupee fell from 108.00 to 120.00 to the dollar during the currency crisis period.
A domestic currency comes under pressure because the central bank refuses to shrink the local monetary base (reserve money) in line with dollar sales and prints money into domestic money markets in a process known as sterilized intervention.