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Sri Lanka plans lentil credit line as money printing drive forex shortages - EconomyNext

Monday August 23, 2021 7:30 am

Monday August 23, 2021 7:30 am

ECONOMYNEXT – Sri Lanka is planning an import credit facility for big ticket items like lentils (parippu) and fuel from supplier countries, Central Bank Governor W D Lakshman said as liquidity injections pressured a currency peg and led to record balance of payments deficits.

The central bank is no longer providing full convertibility for the rupees it is printing to repay domestic government debt or finance expenses at ‘official exchange rate of 200 to the US dollar supposed to operate.

Limited Convertibility

To conserve reserves the central bank is now providing limited convertibility by redeeming rupees, mostly to repay government foreign debt.

As a result banks are unable to find dollars to cover letters of credit for importers to replace stocks bought by customers, especially by state workers who get printed money as salaries or businesses that have borrowed printed money kept in banks, leading to a fall in the value of rupee notes.

Analysts have called on the central bank to stop repaying government debt with printed money (failed bill auctions) to stop the foreign exchange shortages and stem forex reserve losses.

Last week the central bank raised the rate it prints money overnight by 50 basis points to 6.00 percent, but said it will keep a ceiling rate on bill auctions, which had created most of the trouble.

Delaying with Foreign Debt

Governor Lakshman however said there was a discussion with Finance Minister Basil Rajapaksa and also banks on Wednesday about delaying paying for imports with suppliers’ credit.

The idea was to identify big ticket items that are a “big burden” on the balance of payments, he said.

“For example there is petroleum. There are lentils (parippu),” Governor Lakshman said. “What we are trying to do is to get a credit line for those from the country of import.”

“That items we have heard that it has been possible to do for one or two items. We hope to discuss and solve this problem in the future.”

He said authorities hoped to get some time and pay them later.

It is not clear who will bear the foreign exchange risk of the lentil credit line or the interest.

Nick Leeson Debt

Sri Lanka’s state-run Ceylon Petroleum Corporation has run up over 3 billion US dollars of debt, due to a similar line of thinking when money was printed in the past such as in 2018 to target an ‘output gap’ as well as more recent.

As a result, the CPC which has rupee denominated sales, has ended with a dollar denominated loans, or an unhedged forex exposure, leading to what critics call Nick Leeson losses.

The CPC is made to borrow dollars from banks in the years that the central bank run inflationary policy (prints money to keep rates down), such as in 2018, and then when the monetary authority runs deflationary policy (sterilizes inflows) in the inevitable downturn that follows, the loans are paid back.


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In 2018 as money was printed to target an ‘output gap’ and the rupee fell from 153 to 182 to the US dollar the CPC ran an 80 billion Nick Leeson/Supplier credit loss.

In 2018 Sri Lanka ran into a currency crisis despite the CPC market pricing fuel and being awash in rupees which could have been used to buy dollar had there been no ‘output gap’ targeting.

In 2018 liquidity was also injected by doing a so-called Soros style swap with the Treasury.

However as money printing created forex shortages, the CPC was made to borrow dollars despite having rupees in repos in state banks which were then loaned to other borrowers to trigger non-oil imports.

Sri Lanka’s The Sunday Times newspaper reported that in June 2021 that CPC owed Peoples’ Bank 1,075 million and Bank of Ceylon 1,006 million dollars for such loans.

Oil suppliers had to be paid anoher 597 million US dollars through Letters of Credit issued by the People’s Bank and 677 million dollars though LCs issued by the Bank of Ceylon, or a total of 1.74 million dollars the report said.

With deflationary policy being followed only in 2017 and 2019, the last administration was also forced to borrow dollars to repay foreign debt instead of squeezing the current account. Instead of running deflationary policy to repay debt, the last administration also enacted an ‘active liability management law’, critics say.

Investors in rupee securities also fled amid monetary instability and real effective exchange rate targeting.


Sri Lanka sovereign bonds trebled to US$15bn over 5-years: Minister Cabraal

Due to a combination of effects from 2015 to 2019 Sri Lanka’s outstanding International Sovereign Bonds had zoomed from 05 billion dollars in 2014 to 15 billion US dollars in 2019.

External Deficits

Such import loans or suppliers credit tend to worsen trade deficits and the current account deficit.

The suppler credit or import loans expand the external current account deficit by that amount by giving additional resources for the domestic economy and preventing a correction in domestic credit and consumption.

Sri Lanka has a long history of worsening current account deficits from such borrowings due to Mercantilism and lack of knowledge of classical economists after setting up a Latin America style central bank to join the failed Bretton Woods system.

At one time the International Monetary Fund also used to give such Mercantilist loans and Sri Lanka had also borrowed them, instead of running corrective measures.

These include loans from the IMF’s Compensatory Financing Facility (CFF), Buffer Stock Financing Facility (BSFF) and oil facility.

Sri Lanka’s non-credible peg typically gets into trouble on two occasions, due to policy changes in the anchor central bank the Fed, analysts have said.

First when the Fed prints money and fires a commodity bubble, money is printed to finance energy subsidies or keep rates down as SOE borrowings from banks go up.

The second collapse happens when Sri Lanka cuts rates and injects money to keep growth up even as Fed tightens policy. At such time the currency will fall even if oil prices collapse due to Fed tightening.

Countries that depend on commodity exports for revenues will also usually print money if they have a central bank as prices fall, leading to currency troubles.

In 2021 oil and other commodities are moving up due to the Fed’s Powell Bubble.

Analysts and economists have called for reform of the central bank law to curb the powers of the domestic operations to end monetary instability. (Colombo/Aug23/2021)