Oct 01, 2008 (LBO) – Sri Lanka’s central bank said it had achieved reserve money targets set for the September quarter amid a reserve outflow that has made it increase domestically injected liquidity to maintain reserve money. Such actions, characteristic of maintaining a pegged exchange rate, known as ‘sterilized intervention’ can easily stampede a country into a full blown currency crisis if allowed to continue.
The cycle however can be broken by ‘floating’ the currency.
In 2007, the bottom fell out of the central bank’s quantity targeting framework due to such actions.
Economic analysts say soft-pegged central bankers sometimes behave like children, obstinately trying to preserve a currency peg, and the monetary base (reserve money) at the same time and driving countries into serious balance of payments difficulties and high inflation.
Meanwhile under Sri Lanka’s monetary law the central bank could also effectively appropriate foreign reserves to settle foreign liabilities of the government without going to parliament for approval again.
But yesterday the central bank allowed the rupee to break its peg, and after spiking to 108.50 the rupee settled at around 108.10/20 to