Tuesday 2 May 2017

Money printing, gold gains, boost Sri Lanka central bank profits

ECONMYNEXT - Profits at Sri Lanka's central bank rose to 22.1 billion rupees in 2016, returning from a loss of 19 billion rupees in 2015 helped by interest income from a massive bout of money printing that stated in the latter half of 2015, sending the rupee tumbling.

Interest income from Treasury bills bought to print money rose to 21 billion rupees as the central bank held a portfolio of around 300 billion rupees of bills earning interest, from 9.3 billion rupees in 2015, data showed.

Most of the money was printed in the latter half of 2015 as the central bank sterilized dollar interventions with liquidity triggering a balance of payments crisis.

Half-baked regime

So-called soft-pegged or 'half-baked' monetary regimes found in Sri Lanka and Latin America are prone to BOP trouble.

Central banks following soft-pegged regimes print money and to delay interest rate rises when state or private credit demand picks up, undermining the credibility of the peg.

When investor sell out or exporters hold back dollars, more dollars are sold and more rupees are printed to fill liquidity shortages.

A vicious cycle of interventions and liquidity shortages feed into each other, driving the soft-pegged monetary system into a full-blown balance of payments crisis.

The central bank's Treasury bill stock or high yielding 'domestic assets', rose to 351 billion rupees on December 31, 2016 from 102 billion rupees a year earlier.

For most of the year a portfolio of 200 billion rupees to 250 billion rupees was maintained by the central bank earning rupee interest.

The December 2016 surge in Treasury bills to 351 billion rupees was partly caused by money printed to repay a maturing bond, in what analysts warn is a dangerous game of fiscal dominance indulged by the Treasury.

Data also showed that provisional advances were reduced from 151 billion rupees to 83 billion on that date.

Domestic Assets

Provisional advances also represent printed money which earns no interest for the central bank.

Though forex reserves fell as money was printed to generate the balance of payments crisis, total profits went up as earnings on Sri Lanka government rupee securities (domestic assets) are higher than the earnings from US dollar and Euro bond in reserves (foreign assets) where rates are much lower.

The central bank's sterilization costs were also down with rupee interest expense down to 2.1 billion rupees from 8.9 billion a year earlier. In the early part of 2015, there was excess liquidity from buying dollars, which were sterilized at the expense of the central bank.

A central bank will generally make small profits or lose money when it keeps inflation low, and make large profits when in generated monetary mayhem by depreciating the currency and printing money to finance a government.

The builders of the pre-cursor to modern central banks, The Bank of England also expected to make profits primarily by printing money to finance King William as Sri Lanka's central bank finances the budget deficit by purchasing Treasury bills

But privately owned gold-backed central banks hiked rates and stopped printing as soon as it started to lose gold reserves under its explicit convertibility undertaking as shareholders did not like to lose gold reserves.

Sri Lanka's state-owned central bank however continues to print money despite losing forex reserves as no one is held accountable. Instead an implicit convertibility undertaking is defaulted and the currency depreciated instead of raising rates.

After depreciation rates are raised anyway, in what critics call a 'rawulath ne kendeth ne' operation in reference to a local idiom.

In 2016, the central bank not only failed to tighten policy but also cut rates despite an expanding budget deficit and rising credit in an extraordinary policy move.

Twin Errors

In the second half of 2015 it also made a 'failed float' of the rupee without hiking rates leading to currency collapse followed by more forex reserve losses, leading to further weaknesses in the rupee.

The large Treasury bill portfolio the central bank had in 2016 was a consequence of both actions.

In 2015 the central bank lost money despite generating currency depreciation partly due to gold losses and forex swap losses as the currency fell.

In 2016 the central bank made an 8.3 billion rupee gain on its gold portfolio against a loss of 17.3 billion in 2015.

Foreign currency swaps brought gains of 5.7 billion rupees against losses of 11.5 billion a year earlier, amid a relatively stable currency.

Analysts have called for the central bank to be abolished and a currency board re-created to eliminate balance of payments crises and or the central bank reformed to reduce its discretion to delay rate hikes and generate monetary instability.

A currency board would have the double benefit of being a hard budget constraint and ending budget deficits.

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