Sri Lanka forex sales pick up amid excess liquidity

Nov 15, 2010 (LBO) – Sri Lanka’s central bank has sold 288.7 million US dollars in foreign exchange markets in October in one of the biggest monthly sell-off of accumulated reserves in two years. In a sustainable pegged exchange rate regime such sales are an automatic quantity adjustment process that trims the monetary base (reserve money) to economic needs, draws in imports and prevent inflation and asset price bubbles.

The excess liquidity is reduced either by the holders of such deposits spending it, or by banks lending it to other customers who will spend it, which will expand economic activities and draw in imports for consumption or for building capital stock.

However banks need good projects to lend the money to make sure that the depositors’ money is safeguarded. As Sri Lanka is emerging from a downturn, such projects can take time.

Central Bank governor Nivard Cabraal had said that he would like banks to lend to good projects so that the asset quality of the banking system is strong.

Sri Lanka is just recovering from bad loans and collapsing property speculating fired by deficit spending and artificially low interest rates from 2004 to 2007.

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