Sri Lanka warned against excessive foreign reserves

Mar 24, 2010 (LBO) – Holding large foreign exchange reserves could actually be a burden for Sri Lanka’s government and deny funds from badly needed infrastructure and health care, a senior corporate executive has said. Sanjoy Ray, Finance Director of Finlays Colombo said that while foreign exchange reserves could act as a buffer against emergencies, they come at a cost.

“What is not always appreciated is that, beyond a point, a large reserve means a huge ‘opportunity cost’ for the country,” Roy told shareholders in the firm’s annual report.

He likened foreign exchange reserves to a business holding very high inventory which is financed by big borrowings.

“The government has to spend a significant amount of money on building reserves that it could have used to build schools, health clinics and roads,” Ray said.

“Holding excessive reserves is a burden on the economy. The real beneficiaries of large reserves are those in whose currencies the reserves are held.

“As the appetite for holding reserves grows, developed countries get access to a ready market for selling their Treasury Bills and Bonds at low cost.”

Sri Lanka had built up foreign exchange reserves of about five billion US dollars by end-2009, as it recovered from a balance of payments crisis with the help of International Monetary Fund loans and increased private capital flows.

Ray also referred to China’s large foreign exchange reserves, the world’s largest at nearly 2.4 trillion dollars, most of it invested in US bonds.

“It is said that China has, in effect, funded the tax cut for the richest people in the richest country on earth.”

The United States receives a large volume of low-cost imports from China while Beijing’s Treasury bond holding virtually finances the snowballing US budget and current account deficits

Sri Lanka’s government should carefully develop a plan regarding the optimum amount of foreign currency reserves that it needs to hold, Ray suggested.