ECONOMYNEXT – Sri Lanka’s bank credit surged in March 2022 after a soft peg collapsed and banks’ dollar-pound values ballooned in domestic currency as a middle-tier central bank tried to regain control reserve currency through a float.
Intermediate regimes (central banks with foreign exchange reserves that also engage in aggressive open market operations to print money and keep interest rates low) are the most dangerous monetary regime invented by mercantilists .
In March 2022, the rupee fell from 201 against the US dollar to 299 based on official data, inflating the rupee value of dollar loans, in the biggest economic crisis triggered by the Latin American-style central bank in 72 years of history.
Liability Dollarization Inflation
Total banking system credit to government, state-owned enterprises and private businesses jumped 1.2 trillion rupees in March from 128 billion rupees a month earlier as the dollar pound swelled.
Commercial bank credit to the government increased by 209 billion rupees, of which 137 billion rupees came from inflation from pounds to dollars.
Credit to SOEs also increased by 310 billion rupees, including 77 billion rupees from foreign banking units.
Private credit increased by 694 billion rupees in terms of rupees, including 221 billion rupees from overseas banking units. It is unclear whether national units also have dollar loans.
Central bank credit also increased by 240 billion rupees in March.
Sri Lanka goes from monetary crisis to monetary crisis due to the intermediate central bank regime which has peg conflicts in line with the so called “impossible trinity” of monetary policy objectives triggering foreign exchange and trade controls when money is printed, suppressing interest rates.
The country’s Latin American-style central bank was established in 1950 and it visited the International Monetary Fund 16 times as the soft peg came under pressure from low interest rates kept down by money printing.
The absence of any appreciation of the value of monetary stability (sound money) as the basis of economic growth is found both in Third World economists and also in Western prescriptions for the Third World, which favor unstable intermediate regimes that put discretion above rules under the guise of central bank independence, critics say.
Sri Lanka itself was following flexible inflation targeting (discretionary domestic anchor) while applying a flexible exchange rate (discretionary external anchor) which led to three currency crises in 2015/16, 2018 and also 2020/2021/ 2022 which is still ongoing.
Legislators and interventionist economists have opposed single-peg monetary regimes (currency board or own float), while pretending to defend the impossible trinity of monetary policy goals.
While dollar credit swelled in March, rupee borrowing by private companies is also trending higher as the collapsing currency inflates prices and working capital needs rise, analysts have warned more early when flexible discretionary inflation targeting and output gap targeting became official policy.
Distress borrowing also tends to increase in these countries unless the exchange rate stabilizes.
By the end of April 2022 consumer price inflation reached 29.8%.
Analysts have blamed the International Monetary Fund for providing technical assistance to calculate an output gap, which was targeted with cash injections, ultimately destabilizing a country at peace through a series of currency crises.
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“Gone are the days when most people in positions of authority viewed exchange rate stability as an advantage,” commented Ludwig von Mises, a classical economist.
“The devaluation of a country’s currency has now become a regular means of restricting imports and expropriating foreign capital.
“It is one of the methods of economic nationalism. Few people now want stable exchange rates for their own country. their own country, they say, is fighting other nations’ trade barriers and the progressive devaluation of other nations’ monetary systems.
“The stability of exchange rates was in their eyes a bad thing, not a blessing. This is the essence of Lord Keynes’ monetary teachings. The Keynesian school passionately advocates the instability of exchange rates.
Ironically, East Asia, including China, had until 2005 some of the strongest exchange rates in the world, either orthodox policy-neutral currency boards or more stringent regimes than currency boards. issue where foreign exchange reserves exceed the reserve currency. (Colombo/May 16/2022)