Dec 09, 2011 (LBO) – Sri Lanka’s foreign reserves slipped 11.8 percent to 7,095 million US dollars by end September from a month earlier, amid defence of a soft dollar peg, official data showed. The trade deficit expanded 93.6 percent to 6.8 billion US dollars. The trade gap is driven by income derived from net foreign state borrowings and worker remittances and foreign direct investments as and when they are spent.
However when dollar sales are sterilized with liquidity injections, they also add to the trade deficit requiring a float to break the cycle of sterilized intervention and restore credibility of the peg.
The Central Banks said inflows to the government were 3.4 billion dollars up to September up 48.1 percent, remittances were up 25.9 percent to 3.78 billion dollars and earnings from tourism were up 48.1 percent to 580.1 million US dollars.
Foreign direct investment was up 98.6 percent to 413.0 million US dollars.
The central bank said reserves were equivalent to 4.6 months of imports.
Sri Lanka has a dollar soft peg, where the central bank tries to control both the exchange rate and the interest rates.
The peg which was around 110 rupees to the US dollar came under pressure from high credit growth and lower than needed interest rates from around the third quarter of 2011.
Sri Lanka’s foreign reserves hit a high of 8,050.1 million US dollars by end August following the sale of a sovereign dollar bond, but the peg was already under pressure at the time.
In November the peg was re-set at 113.90 in a surprise budget decision, and dollar sales to defend the peg and liquidity injections to ‘sterilize’ the shortages in money markets are continuing at the new level.
But interest rates have adjusted upwards from the second week of September, which analysts say can reduce the underlying pressure on the peg.