Oct 28, 2010 (LBO) – Sri Lanka has higher than ‘optimum’ foreign reserves, Central Bank Governor Nivard Cabraal said as a wide interest rate differential with the island’s anchor currency, official borrowings and International Monetary Fund injections boosted reserves. As long as sterilization continues (rupee injections), economic participants get unlimited ammunition to hit the exchange rate and deplete any amount of foreign reserves.
The problem with the ‘open economy trilemma’ (which says it is not possible to have an exchange rate peg and maintain a domestic monetary policy without capital controls) has worsened with sales of rupee debt to foreigners, who can exit without capital controls.
The policy contradictions last came to a head in late 2008 and Sri Lanka’s reserves of 3.5 billion dollars fell to 1.2 billion over seven months until rupee injections ended with a float of the currency in April 2009.
Since then about half of a 2.5 billion US dollar IMF bailout package and about a billion dollars from a foreign fund has helped boost reserves in addition to purchases from the forex markets.
Sri Lanka is pegged to the US dollar and the country has a policy rate of 7.25 percent, far higher than the 0.25 percent level of its anchor currency.