Sri Lanka’s foreign reserves fall to US$1.4bn in Jan 09

Mar 18, 2009 (LBO) – Sri Lanka’s gross official reserves fell to 1,415 million US dollars from 1,753.4 million dollars in December 2008, which was enough to cover 1.3 months of imports, the Central Bank said. With Asian Clearing Union balances, reserves were 1,703 million US dollars.

But imports were contracting sharply amid a global deflationary environment and lower demand at home.

The import spend had fallen 40.5 percent to 699 million US dollars in January 2009, against the same period last year. The fall was broad-based, but was led by petroleum, the central bank said.

Sri Lanka’s currency came under pressure from September when the central bank began to defend a dollar peg and injecting liquidity into money markets in a self re-inforcing cycle known as sterilized intervention, triggering a balance of payments crisis.

At the time Sri Lanka’s foreign reserves were at 3.4 billion US dollars.

The steep fall in the import and oil bill has left authorities without the usual suspect to blame for balance of payments crises, which is imports in general and oil in particular.

Nobody has explained why only oil is ‘bad’ for the exchange rate. Other types of imports such as capital goods are not blamed by authorities for currency depreciation. Sri Lanka has already requested a bailout from the International Monetary Fund, which necessary to maintain external solvency of the country.

Earlier in the day the Central Bank announced a relaxation of import curbs which were slapped late last year.

IMF also advocates such action, as import curbs simply stifle economic growth and limits the economic freedoms of the entire population, without having any beneficial effect on the exchange rate.

A balance of payments crisis is monetary phenomenon coming from excessive new liquidity injections to the domestic monetary system to offset cash lost due to foreign exchange sales by a monetary authority.

Sri Lanka runs a ‘soft peg’ or ‘managed float’ where the central bank targets both the exchange rate and the interest rates, or domestic money supply, which are incompatible goals.

The island has experienced repeated balance of payments crises and high inflation after a currency board which kept the exchange rate fixed through a ‘hard peg’ was abandoned and a central bank with money printing powers was created in 1950.

The central bank said private remittances from expatriates fell by 6.6 percent to 274 million US dollars in January.

Falling remittances also do not put any additional pressure on the exchange rate in a pegged exchange rate environment.

Lower inflows contracts the spending power of citizens within a country and causes a corresponding fall in imports.

Rising remittances (unless saved in foreign currency banking units and lent abroad) will also simply trigger more economic activity and imports in a ‘managed float’ or pegged exchange rate environment.