With just about six months of allowing people to get on with their economic lives peacefully, Sri Lanka’s central bank has bombarded the monetary system with tens of billions of printed rupees to unleash another bout of instability.
The current administration’s economic performance is – not all – but mostly due to the monetary instability and trade controls that came from the deadly ‘flexible exchange rate’.
Given the recent excessive monetary instability generated by the central bank – let’s face it we have a gold-taxing, Nixon shocking central bank, what more needs to be said? – the public should view the planned reforms to the central bank with great suspicion.
A modern central bank, by virtue of being a state agency with a monopoly, has power which is no ordinary Mercantilist has, except perhaps agencies like the British East India Company which had its own army and lawmaking powers. The Governor and the Company of Bank of England was also a classic Mercantilist organization, but it was privately owned.
Sri Lanka’s central bank and that of India is wielding their monopoly power, with the same ruthless discharge of the control mindset but with greater powers than any 17th century Mercantilist ever had. Given what was done to the people since 2015 in particular with a collapsing currency, REER targeting, gold taxes, car taxes, LTV controls on three-wheelers no less, the planned monetary reforms should be viewed with the most considerable caution. What Adam Smith said of Mercantilists is very real of Sri Lanka’s central bankers or that of India or Pakistan.
“The proposal of any new law or regulation of commerce which comes from this order ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous but with the most suspicious attention,” he wrote in the Wealth of Nations.
“It comes from an order of men whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”
[pullquote]ON AUGUST 08, 20 BILLION RUPEES WAS PRINTED SUDDENLY ON TOP OF UNSTERILISED EXCESS LIQUIDITY[/pullquote]
MONETARY WINDOW DRESSING
What is confusing is that the central bank is now promising to end money printing, apparently genuinely. If the promise to end money printing was genuine, what happened in August 2019 should not have taken place. The current printed money land mines were set off barely days after this columnist wrote is support for the planned controls on money printing.
Up to around July dollars were bought to create money and rupees were mopped up steadily by selling down Treasury bills. There were also overnight repo auctions. On July 17, 17 billion rupees in excess money was deposited at the floor rate window.
Then mopping up stopped and excess liquidity started to build up, probably from dollar purchases. On August 08, 20 billion rupees was printed suddenly on top of unsterilised excess liquidity. There were also term injections and outright purchases around the time.
These cash bombshells show that even if by law the central bank is stopped from taking large volumes of bills from the auctions, it will take them through other means and dump reckless quantities of liquidity on money markets. It will then be justified based on conducting ‘monetary policy’. When one avenue is blocked, the central bank’s domestic operations department finds another to generate instability. Then on August 16, the central bank suddenly brought down its Treasury bill stock to Rs77.8 billion from Rs106 billion. Before that, up to Rs25 billion of money was printed overnight and also through term reverse repo contracts. A few years ago, the bank stopped showing the total bills it takes against central bank credit to the public and understated the bill stock. Was it done to hide the actual bill stock from the people?
The great window dressing exercise left Rs50 billion of excess liquidity in the banking system. The rupee went sliding.
[pullquote]WHAT IS CONFUSING IS THAT THE CENTRAL BANK IS NOW PROMISING TO END MONEY PRINTING, APPARENTLY GENUINELY[/pullquote]
FLOATING WITH EXCESS LIQUIDITY: A CRIME
A look at recent spikes in excess liquidity tells its own story. In April 2018, the central bank printed tens of billions of rupees, after releasing liquidity in March. In April the exchange rate can be seen absolutely flat. The central bank was buying dollars (even as it was printing money) in April when remittances come, and export firms convert dollars to pay salaries. It was pegging with a strong side convertibility undertaking – i.e. preventing the rupee from appreciating. Then after excess liquidity spikes and the pressure on the exchange rate develops, the exchange rate is floated without mopping up excess liquidity. The central bank, which stops appreciation and buys dollars with great enthusiasm, is markedly reluctant to do the same in the opposite direction. In fact, to deploy weak-side convertibility undertaking the fall has to be ‘disorderly’.
Why not also buy dollars only if the appreciation is disorderly? Talk about a weighted dice. Not only is there a bias to depreciate, but the central bank also floats the rupee with excess liquidity, built up during the pegging period with the acquisition of foreign assets (dollars) or Treasury bills (domestic assets). Or both as in the case of August 2019. No attempt is made to withdraw the liquidity to make the monetary system ready for a float. As a result, the currency slides, importers and foreign investors panic, then exporters hold back. This bias against the helpless rupee should be criminalised as fast as possible. In August 2018 (last year), after the rupee stabilised from the April-May shock, the central bank again bought dollars at around 160 to the US dollar.
[pullquote]THIS COUNTRY HAS SUFFERED TOO LONG AT THE HANDS OF SOFT-PEGGERS. FROM 1951 TO 2019[/pullquote]
Laughably, the central bank bought dollars through a swap – Singapore has outlawed swaps even for third party banks though Hong Kong hasn’t – and dug its own grave.
Does the central bank believe that rupees created from dollars are different from rupee created from T-bill purchases, and they cannot push the peg down?
There are two reasons which make rupees created from dollars better than rupees created from T-bill purchases, but both have the same downward pressure on the peg. One is that there are dollars in reserves to defend. The other is that when the dollars are sold, liquidity tightens and the overnight rates go up, to strengthen the peg. But none of this will happen if the call money rate is targeted with new printed money. It is not necessary to have substantial shortages. A cash short of about 5 to 10 billion rupees in enough. Then banks can borrow from the lending window at the ceiling policy rate, and the currency can be floated.
IT’S THE CALL MONEY RATE, STUPID
James Carville, campaign manager for Bill Clinton, once said [its] the economy, stupid.
All that this columnist can say is that ‘It is the call money rate, stupid. The greatest virtue of buying dollars is that it can be sold, and when it does the call money and repo rates go up. Repo rates are a good indicator of actual market conditions, and since the feedback loop is very fast.
This central bank, in the run-up to the August/September 2018 monetary debacle, kicked the primary dealers out of the system because they were bidding at high rates for money? Can anyone believe this? Yet it is true.
At the press conference after the last rate cut in 2019, the central bank officials had told the media that it was trying to control the call money rate.
Why is there a two-way policy rate? It is to help keep the exchange rate strong.This central bank recently made a lengthy statement about its monetary policy framework and flexible inflation targeting – whatever that is – and the impossible trinity of monetary policy objectives. It was an absolutely anti-bullionist, banking school type of work, which was full of contradictions. But that is fine. If the anti-bullionists did it, why not Sri Lanka’s central bank?
But if anyone can understand the impossible trinity, why target the call money rate and then buy dollars to keep the rupee down? Then how come the rupee is defended – only after a disorderly fall, mind you, showing the bias to depreciate – while the call money rate is targeted?
Only the Saman Deviyo will know the thinking of soft-peggers.
If that is the thinking, if August 2019 is a sample of things to come, this columnist shudders to think what may be in the amendments to the Monetary Law Act.
STATE FAILURE
This country has suffered too long at the hands of soft-peggers. From 1951 to 2019. But there is no end to this suffering and hardships insight. It seems the deadly downwardly – disorderly – biased, ‘flexible exchange rate’ is the solution.In 2019, there is also unprecedented financial repression. Is this 1971 or 2019? Is Sirimavo Bandaranaike the Prime Minister or is it Ranil Wickremesinghe?
[pullquote]A NIXON SHOCK IS A STATE FAILURE. CURRENCY COLLAPSE IS STATE FAILURE. SRI LANKA’S CHRONIC HIGH INTEREST RATES ARE A STATE FAILURE[/pullquote]
Sri Lanka’s markets are working. In fact, the banking sector is competitive enough so that deposit rates are high enough to compensate poor savers as well as the less poor with financial savings when the currency collapses due to state failure. It is one market that is working efficiently against the massive state failure that is the central bank and its flexible exchange rate and call money rate targeting and flexible inflation targeting. To compensate for its state failure, the central bank has hit depositors with price controls. Borrowers are now to get a subsidy, and banks are going to be hit with price controls. Not a single banker lifted a finger to stop deposit controls. In fact, they made a pact with the devil.
NOW LET THEM SELL THEIR SOUL
All of this will not take the country anywhere. A Nixon shock is a state failure. Currency collapse is state failure. Sri Lanka’s chronic high interest rates are a state failure. Even China had high interest rates before the 1993 peg. Then rates plummeted.
The structurally high rates are a direct result of monetary instability. Banks are working to save the people from state failure. This columnist, as well as other observers, had assumed that the central bank was withdrawing liquidity at 7.70 percent above the 7.50 floor rate, out of an abundance of caution. The August debacle, where money was injected recklessly, shows that there was no such prudence at all. The CB was mindlessly targeting the call money rate it seems, going by media reports. There is no point in talking about monetary reform if large volumes of money are printed to generate liquidity spikes.
CRIMINAL ACTIONS
Will criminal punishments work? In an earlier age, those who generated monetary instability and high inflation with large volumes of printed money were guillotined or beheaded. No such gruesome punishments are needed. But some type of accountability is a must. The other aspect is that politicians are being blamed for errors coming from targeting short or long term rates with printed money.
People will kick out politicians, and they will pay the price, regardless of whether they do or do not pressure the central bank to print money. But central bankers have continued to commit the same errors. They do the same in Turkey, in Russia, in Nigeria, In Argentina and in Iran.
Actions which caused the most significant damage in recent years which have to outlawed or criminalized are as follows.
The buffer strategy (repaying long term bonds with central bank re-financed lender of last resort money injected to state banks).
Soros style swaps. The damage is less because dollars are in reserves and they can be sold to mop up the liquidity – as long as the liquidity has not been borrowed already and used for imports.
Filling liquidity shortages after giving dollars for maturing 2013 swaps without allowing rates to hit the ceiling rate.
Injecting cash after going without sterilising dollar purchases for more than 2 weeks. This is what happened in August 2019.
Operation twist (a two-leg operation that contributed to the 2015/2016 BOP crisis where long term rates are manipulated)
Floating without taking away excess liquidity and not allowing rates to move up to the ceiling policy rate. This happens all the time under the deadly ‘flexible exchange rate’. It is not necessary to have large shorts. About 5 or 10 billion rupees is enough. The critical outcome is for rates to move up quickly and then come back down. Prolonged liquidity shortages trigger output shocks.
Cover-up moves to delay rate hikes. Nixon shock style import controls, gold taxes are covering up for call money rate targeting or other policy errors and delaying corrections. The following central bank actions cause less damage, but they should also be restricted or some penalties set.
Going for more than 2 weeks without sterilizing inflows. Going for more than 4 weeks with sterilizing inflows – double the punishment for two weeks.
T-bill window dressing, like that seen in August. The 50 billion rupee liquidity bubbles that led to sharp downward pressure on the rupee indicate that strict limits must be brought against excess liquidity to keep domestic operations.
A limit must be placed to stop excess liquidity from exceeding 2 percent of the monetary base. If the central bank is willing to allow short term rates (call money and repo) to move up and is ready to defend the rupee with the same enthusiasm that it buys dollars to prevent appreciation, then high volumes of excess liquidity could be tolerated.
It must also be noted that most of these individual wrong policies are undertaken to target the call money rate. Cutting deposit rates on top of currency depreciation is mass expropriation of the weakest and helpless persons and old people. As Sri Lanka’s population ages, such actions that undermine markets and harm the weakest in society must be outlawed.