Sri Lanka central bank net forex buyer in April: official data

May 11, 2009 (LBO) – Sri Lanka’s central bank has bought 37 million dollars from forex markets in April 2009 in the first full month after ‘floating’ the rupee ahead of an International Monetary Fund bailout, the latest official data shows.

The rupee depreciated despite a collapsing import bill.

Sri Lanka’s central bank has also cut interest rates, which analysts say could put further pressure on the rupee, though ‘de-leveraging’ in the form of contracting private sector credit could slow the process.

Though it is not possible to target the exchange rate and interest rates (print money) at the same time, many so-called ‘soft-pegged’ central banks attempt to do so, triggering balance of payments crises or very high inflation.

Economic analysts say the belief that significant foreign exchange outflows (or export surpluses) could be sterilized without short and long-term negative effects to the economy stems from advice peddled by the Federal Reserve during the last century, especially to Latin American central banks.

Latin American nations, which have soft-pegs with the US dollar have become synonymous with balance of payments crises.

Sri Lanka’s central bank was also created by a Federal Reserve official.

Correction. Net purchases US$37.25 There were no sales of foreign exchange by the central bank in April, indicating that Sri Lanka’s balance of payments crisis may may be easing.

The bank bought 37.25 million dollars during the month.

The rupee was floated in late March as a prior action for an IMF bailout. In March the central bank was also able to buy 73.5 million US dollars, though sales of 127.50 US dollars exceeded purchases.

The rupee has floated between 116.50 to 120.00 rupees to the US dollars in the past three weeks.

A float is needed to break a peg defence cycle of simultaneous interventions in foreign exchange and domestic money markets (sterilized intervention) by a central bank which causes reserve losses and puts pressure on the exchange rate.

Sri Lanka ran into a balance of payments crisis after the central bank started to defend a peg with the US dollar at 108.00 rupees last September by sterilizing outflows, losing more than two billion dollars in the process.

Sri Lanka’s gross official reserves, which include fiscal reserves, were down to 1,369 million US dollars in February down from 3,424 million US dollars at the beginning of September 2008.

The central bank’s net reserves fell from 3,074 million to 1,117 million US dollars in the same period.