Sri Lanka’s balance of payments deficit climbs to $ 2.7 billion through July 2021 as bond auctions fail
ECONOMYNEXT – Sri Lanka recorded a balance of payments deficit of $ 2.755 billion until July 2021, according to official data, a record high as historically high levels of liquidity were injected to develop unsustainable credit, stimulate imports and also sterilize debt repayments.
In 2020, Sri Lanka had a balance of payments deficit of US $ 2.373 million, the highest annual deficit in the history of the central bank at the time, applying so-called “alternative” or “theory” policies. modern monetary policy ”to keep interest rates low.
Sri Lanka has had balance of payments or liquidity injections problems even since a Latin American-style central bank modeled on Argentina’s was created by an American money specialist in 1950.
America’s money medics set up similar central banks with extensive (counter-cyclical) money printing powers to suppress interest rates, resulting in chronic currency collapses, followed by a sovereign default and ultimately dollarization generally.
The balance of payments deficit for the year 2020 has now been exceeded in the first seven months of July 2021. Part of the balance of payments deficit in 2021 (nearly billions of US dollars) was triggered by remaining cash injections from the 2020 deadline, which were used as private lending resumed.
The deficit in the balance of payments roughly corresponds to the decline in net international reserves, which are gradually reduced as foreign currency outflows exceed inflows (foreign exchange shortage) due to new money injected into the banking system and the budget.
Banks can lend money (from maturing bonds that are bought by the central bank after rejecting offers or new bonds purchased to make the coupon payment) to borrowers who, in turn, will trigger imports when they are invested.
Any new bills or bonds purchased by the central bank or money from the permanent deposit window given to refinance the government’s bank overdrafts to the Treasury, will be paid as salaries to government employees who will use the money to buy goods on the market, creating a shortage of foreign exchange when importers replenish stocks.
In the 1970s, when Sri Lanka was mired in multiple trade and exchange controls, at least one classic banking economist knew that buying treasury bills at failed auctions triggered balance of payments deficits. .
“The responsibility for absorbing the unsubscribed portion of treasury bills rested with the central bank,” wrote the classic economist in the Monetary Authority’s 1975 anniversary publication.
“A major disadvantage of financing budget deficits with central bank credit is that, although the process involves an expansion of the money supply, it is not necessarily accompanied by an expansion by a corresponding increase in the national product. ”
“Therefore, the increased demand for central bank financing of budget deficits had to be met by increased reliance on foreign supplies, which put pressure on the country’s external payments.
“Thus, although the government’s fiscal problem and the balance of payments deficits were two separate problems, they were nonetheless intertwined, in the sense that the balance of payments deficits and the loss of foreign assets were linked to each other. resulted in part from the method by which the government sought to finance its deficits.
When liquidity is injected and bond auctions fail, the government is also unable to generate real resources for itself (by reducing domestic credit), which leads to the allocation of foreign exchange reserves to repay the debt. external debt. Reserves are released against treasury bills in an accounting transaction.
If no liquidity was injected (and bond auctions did not fail), the central bank could later sell the treasury bills drawn to sell reserves to the Treasury, reduce domestic credit, force an exchange surplus. and buy dollars.
However, when cash injections to keep interest rates down put pressure on the currency peg, market participants also bet against the peg and / or try to hedge against further declines in the currency. currencies.
These include exporters who accumulate dollar deposits and borrow rupees made cheap by failed bond auctions and the elderly and retirees who stock up on drugs fearing they will no longer be imported. in the future.
In Sri Lanka, according to social media, some members of the public are also stocking up on jockstraps and other underwear after import restrictions were denounced by outgoing central bank governor WD Lakshman.
In the stock market, inflationary expectations have also been reinforced by injections of liquidity and instability of currencies, causing a frenzy of exporters or “dollarized assets”.
Sri Lanka last experienced two successive years of deficit where the second year deficit was larger than the first in 1999 and 2000.
Usually, policy corrections are made to reduce liquidity injections after the onset of a balance of payments deficit in the first year.
The central bank raised policy rates in August, but did not deliver the desired results as price controls on bond and bond auctions triggered more cash injections due to the failure auctions.
Currency crisis tools
Over the past two decades, the central bank has created liquidity injections or balance of payments crises in several ways, analysts have shown.
In 2004 and 2008, liquidity was injected by rejecting actual bids during the auction of bonds.
Prior to that, liquidity had also been injected by not renewing maturing central bank securities, which analysts say is Argentina’s central bank’s preferred BOP crisis method (non-renewal of sterilization securities). Leliq and Lebac).
In 2011, the liquidity injection crisis was created by the non-renewal of forward repo transactions (which amounts to not renewing the sterilization certificates) as well as by the outright rejection of the offers of adjudicating invoices and maintaining fixed bond yields over several months.
In 2015 and 2016, when bond auctions were not sold outside of auctions, liquidity was injected by initially failing to roll over forward repo transactions and maintain overnight rates near the corridor. floor.
“Because the usual tool for rejecting auction bids was not available to inject liquidity, the authorities devised other methods to trigger monetary instability,” said EN business columnist Bellwether.
“After the term repo agreements expired, the currency peg was slapped with reverse repo and reverse repo injections to generate excess liquidity until the rupee collapsed.
“Then the invoices were bought directly from the banks. Later, AS Jayewardene’s “note only” policy was abandoned and bonds were also purchased to inject liquidity, monetize past deficits and manipulate rates deep in the yield curve.
“Rejecting bids for bond auctions also manipulates rates directly beyond overnight and discourages deficit financing with real savings from the private sector.”
In 2018, in addition to slamming the peg of the rupee with overnight injections and forward repo injections, a dollar rupee swap was also used around July to create liquidity when the budget deficit was reduced. .
By buying long-term bonds directly, the central bank also bought bonds and monetized past deficits by turning existing securities in banks into reserve currency, so that paper turned into liquidity and imports.
In 2020, bonds were bought outright outside of auctions, auctions failed with price controls and also a Zimbabwean-style private credit refinancing program for companies affected by Covid-19, and a Mefo Bills-style contractor bill refinancing began to inject liquidity.
In 2021, the balance of payments deficit was mainly due to failed auctions for the most part, remaining cash from 2020, and there were also sterilizations of reserve credits such as the repayment of July bonds.
The liquidity injections in 2020 and 2021 were so severe that the central bank is now running out of net foreign exchange reserves and its reserve liabilities are increasing. (Colombo / Sep 14/2021)