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Sri Lanka’s central bank imposes 5.0% cap on foreign currency deposits

By on August 25, 2021 0

ECONOMYNEXT – Sri Lanka’s central bank ordered a 5.0% cap on foreign currency deposits in a bid to narrow the gap between rupee and dollar yields, according to an ordinance under the country’s banking law .

Sri Lanka last week raised the policy rate at which overnight money is printed to 6.0% from 5.50%, as well as a de facto 12-month rate through which large volumes of silver are printed to keep gilts yields down 55 basis points to 5.93%. which is always lower than the overnight rate.

Yields on the dollar had climbed to around 7 percent.

“The maximum interest rates that can be offered or paid by an approved commercial bank and the National Savings Bank on all foreign currency deposits must not exceed an annual effective rate of up to 5%”, indicates the ‘arrangement.

In the case of special deposit accounts, introduced recently, a higher rate could be paid.

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Sri Lanka caps exporters’ dollar deposit rates

The low rupee rates and expectations of a devaluation had led exporters and others to hold onto the dollar and borrow rupees.

Borrowing rupees to hold dollars should under normal circumstances result in reduced credit for other activities and hence imports, compressing the current account, but with the central bank printing new money, the correction does not occur.

Sri Lanka also plans to borrow dollars abroad through various lines of credit, which will increase long-term debt and further widen the current account deficit in the short term.

Domestic dollar yields started to increase rupee yields from the end of 2020 as money printing (stimulus) and an inconsistent flexible exchange rate (now you give convertibility to the issuance of banknotes, now you don’t) and a growing budget deficit triggered three rate cuts in less than a year.

The downgrade pushed bonds higher over sovereign bond yields and also led to a reduction in the limits on cross-border lending by counterpart banks, creating a serious shortage of dollar liquidity in domestic credit markets.

State-owned banks were also financing a massive dollar position in the state-run Bank of Ceylan, accumulated during the years when money printing (call rate targeting, output gap targeting and MMT) created currency shortages.

The banks also had to repay the loans taken out to buy bonds in dollars under national law (Sri Lanka Development Bonds), the yield of which also increased.

Sri Lanka’s monetary policy had deteriorated sharply over the past five years, with an unusually discretionary policy involving a “flexible” exchange rate (discretionary external anchor) and “flexible” inflation targeting (point discretionary domestic anchoring) exacerbating the years of monetary anchoring conflicts.

The central bank, instead of moving to a coherent policy framework, began to control bond auctions through the so-called “stage III” method, and also imposed controls on lending rates and bank rates. controlled deposit.

Razeen Sally, a classical economist, had warned Sri Lanka against a constant slide of markets towards a centrally controlled or planned economy.

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Sri Lanka caught in a “fatal vanity” of moving away from the markets

“Underlying all of this is a flawed worldview,” Sally said at a conference marking the 69th anniversary of Sri Lanka’s central bank in 2019, after two successive currency crises triggered controls on import.

“It’s a worldview that Lord (John Maynard) Keynes and his Bloomsbury circle shared. And (Friedrich) Hayek accused Keynes and his ilk of suffering from fatal vanity, for the same reason ”,

“Why is the worldview wrong?

“It’s like you can get a committee of really good, super skilled and smart people together. Who are, so to speak, platonic guardians, who have in mind only the public interest. They are the best committee to deal with the complex problems in the world because they know the best.

“They also assume that they have the knowledge to intervene here, there and everywhere as superior to the market, in particular situations.”

“Let me choose a generic example. And it happens all over the world, sometimes here in Sri Lanka as well.

“The generic example is, say, the monetary advice of a central bank which actually tells market participants, starting with commercial banks, what interest rates to charge, to whom to lend, and at what interest rates. conditions.

“And when these market players don’t behave accordingly, they’re annoyed like mean school kids and sometimes threatened with punitive action.”

“In a market economy this is not appropriate and I think it is a fundamental misunderstanding of what a market economy is.

“Particularly because it assumes that a certain committee of good men has better interests and knowledge,” he said. (Colombo / Aug 25/2021)