Jan 25, 2012 (LBO) – Sri Lanka’s foreign exchange reserves fell 23.4 percent to 6,201 million US dollars in November 2011 or 1,897.8 million US dollars from an end July peak, official data showed. The Central Bank said the trade deficit expanded 111 percent to 8.8 billion US dollars in the eleven months to November.
The Central Bank said remittances brought in 4.6 billion US dollars, tourism 830 million US dollars and state borrowings were 4.0 billion US dollars in the 11 months to November.
Exports grew strongly by 22.2 percent to 9.5 billion US dollars.
A trade deficit is caused when domestic market participants earn incomes over and above exports, through other means such as tourism and remittances and the capital account is also in surplus.
The Treasury which borrows abroad more than it repays each year is also a key factor helping drive imports. During balance of payments trouble, liquidity injected by the Central Bank to sterilize interventions can also help generate new imports.
Sri Lanka’s foreign reserves rose to 8,098.8 million US dollars in July 2011, but strong credit demand has put pressure on the currency.
The central bank has injected liquidity (printed rupees) to prevent rates from going up, driving up credit, consumption and imports.
However interest rates have risen since then and some banks have increased deposit rates which will help finance credit by reducing aggregate consumption helping reduce pressure on the peg.
Sri Lanka’s economy is estimated to have grown over 8.0 percent in 2011 and there is strong domestic investment, especially in hotels.
Sri Lanka abolished a currency board or hard peg in 1950 and created soft dollar peg, where interest rates and the exchange rate is targeted at the same time, leading to frequent ‘foreign exchange shortages’ and full-blow balance of payments crises.
Central Bank data showed that up to October 2011, it has sold 1,560 million dollars to commercial banks to defend a dollar peg.
The International Monetary Fund, suspended its program in September as interventions started and wanted Sri Lanka’s peg to be flexible.
The Central Banks said reserves were equal to 3.8 months of imports in November down from 5.7 months of imports in July. Central Bank said in early January end December reserves may be around 6.0 billion US dollars.