April 04, 2009 (LBO) – Sri Lanka has spent only 54 million US dollars defending a rupee peg in March with the island’s central bank selling 127.5 million US dollars in forex markets but also buying back 73.5 million US dollars, the latest official data show.
Sri Lanka originally asked for 1.9 billion US dollars but economic watchers say Sri Lanka could get more under a two year arrangement and if prior actions are implemented on schedule the deal would be approved by IMF executive directors by the last week of April.
The rupee weakened from a peg-defended 114.20 to the US dollar to around 116.10 to the dollar over the past week.
In April Sri Lanka’s exchange rate usually firms up as export manufacturers convert dollars to pay festival advances ahead of a local new year holiday season.
In addition to dollar conversions the central bank also ‘prints’ money into the banking system in April to accommodate a large drawdown of cash out of the banking system in an effective private sector sterilization phenomenon.
However the practice expands the monetary base at a faster rate than there are foreign inflows and results in currency pressure in May, and has been a trigger for minor currency crises in previous years.
In countries that maintain ‘credible’ or ‘hard’ pegs over decades, large festival related cash drawdown are accommodated by reserve shorts, where commercial bank deposits in the monetary authority shift to become circulating money.
This allows the monetary base (reserve money) to remain unchanged, interest rates to sometimes increase, and an automatic adjustment to take place after the festival season as money comes back into the monetary authority.
Sri Lanka lost more than two thirds of its foreign reserves from a peg defence exercise involving outflow sterilization that began in September 2008. Reserves fell to 1.4 billion dollars in January 2009 from 3.4 billion in early September.
Since then Sri Lanka has spent 290 million US dollars on peg defence.
However the data relates only to monetary authority transactions with commercial banks and any reserve appropriations to settle sovereign debt repayments are not captured.
In the last week of March peg defence was largely abandoned, as talks with an International Monetary Fund (IMF) mission in Colombo concluded.
“An IMF mission is back to Washington and continues discussions with the authorities on the latest economic developments and the economic program to be supported by the IMF to improve the country’s balance of payment conditions,” a Fund spokesperson told LBO.
Sri Lankan authorities are expected to stay off forex markets ahead of an IMF bailout package expected in the last week of April.
Sri Lanka also has to fix problems created in the banking sector due to defaulted oil derivatives.