May 09, 2013 (LBO) – Sri Lanka’s forex reserves picked up 30 million US dollars to 6,689 million US dollars, ending two months of declines and is estimated to have increased further in April, the Central Bank said. Domestic credit rose partly due to borrowings by state energy firms to subsidize fuel and electricity. The rupee fell from 110 to 134 to the US dollar as a result.
By end April 2013, forex reserves are estimated to have increased by about another 200 million to 6.9 billion US dollars, the Central Bank said.
Measured in terms of imports, reserves were equal to 4.4 months’ worth imports and 4.5 months in April.
But if foreign reserves are actually used to meet import expenses and defend a currency peg, a country gets into a balance of payments crisis, as it is also the practice of a central bank to print fresh money to keep interest rates down, a practice known as sterilizing interventions.
In order to successfully defend a peg, interventions, (foreign exchange) sales have to be unsterilized.
Sri Lanka’s central bank is now in a phase of sterilizing foreign purchases, by selling down its Treasury bill stock which results in a build-up of foreign reserves. Forex reserves of a central bank represent the net ‘unspent deposits’ in the banking system, analysts say.
Selling down central bank held Treasury bills, drains rupee reserves from the banking system and kills and equivalent amount of domestic credit allowing foreign reserves to go up.
From end March to end April the Central Bank’s Treasury bill stock fell from about 130 billion rupees to about 90 billion rupees.
Sri Lanka lost about two billion US dollars of forex reserves from mid 2011 to mid 2012 as the Central Bank bought more than 200 billion rupees of Treasury bills to generate liquidity and drive domestic credit to unsustainable heights.