Sri Lanka central bank on sell side of peg

June 06, 2011 (LBO) – Sri Lanka’s central bank has been on the sell side of its dollar peg for two months in a row, selling more than 250 million US dollars to maintain the exchange rate, official data show. In May the Central Bank sold 130.15 million US dollars to forex markets on the back of 127.55 million a month earlier.

In most years the Central Bank is a net buyer in April as export firms convert dollars to pay advances to workers and the state also prints money for the same purpose. However in May there is usually an adjustment in the opposite direction.

The recent dollar sales have been accompanied by a reduction in rupee liquidity in the banking system indicating that the monetary authority’s balance sheet is shrinking in step with the dollar sales and the interventions are not sterilized.

Balance of payments crises develop when interventions to maintain a foreign currency peg are sterilized with fresh liquidity injections giving more money for banks to lend and driving up import demand in a vicious cycle.

Non-sterilized interventions on the other hand tighten the monetary system. Excess rupee liquidity is not considered a part of the officially defined monetary base, though its effects are similar.

The rupee traded at 109.50/55 on Monday, with a guidance rate being given to markets at 109.20/70, through state banks, dealers said.