ECONOMYNEXT – Sri Lanka’s external financial account turned negative in 2023, official data show as bilateral lenders stopped financing the government, multilaterals had to be paid, and banks repaid credit lines which counterparties refused to roll over.
The financial account was 1.3 billion dollars in deficit in 2023, subject to errors and omissions of 318 million dollars.
Sri Lanka defaulted on official credit in April 2022 after money printed to keep an artificially low policy rate depleted forex reserves, but the country had to repay multilateral lenders and banks and to repay counterparties.
Though rates were hiked in April 2022, the Reserve Bank of India gave credits to the central bank, leading to more money printing to offset interventions, delaying a correction in the external accounts.
Heavy Outflows
The balance of payments turned positive only in the third quarter of 2022 and monetary stability was restored. A positive overall balance of payments also denotes outflows through the central bank.
According to balance of payments data released by the central bank, other banks (deposit taking corporations) had repaid 1.8 billion dollars to counterparties in 2023 as they were unable to roll-over credit lines, though there was a halt to official payments.
Later banks also built-up foreign deposits (in NOSTRO accounts and elsewhere) when Sri Lanka Development Bonds were repaid in rupees, by curtailing domestic credit.
The central bank also built-up reserves and repaid some loans to Bangladesh and the International Monetary Fund in 2023, after monetary stability was restored.
When outward payments are matched by changes to domestic investments and the financial account is negative, the current account turns positive automatically as long as the central bank does not engage in inflationary open market operations to drive up credit and imports.
However, if money is printed including through outright purchases or term reverse repo operations and they are loaned by banks for domestic investments, forex shortages emerge and no repayments can be made.
Since the rate correction in April 2022, Sri Lanka has repaid debt or collected reserves of about 5 billion dollars based on central bank data.
Related Sri Lanka repays debt or collects reserves of U$5bn via banking system since rate correction
Neo-Mercantilism
Keynesians however believe it is something to do with the external current account, in a regression to classical mercantilism and is not related to inflationism.
The problem figured in discussions between classical economists and Keynes in the 1920 as the Fed’s policy rate infected other countries and the ‘age of inflation’ (and the age of balance of payments deficits) began to emerge.
Classical economists pointed out that Germany was unable to make external repayments (reparations) after World War II because the Reichsbank printed money and created forex shortages while also borrowing abroad driving imports and there was no sudden surge in exports required as claimed by Keynese.
All the German government had to do was to raise money domestically (by taxing or borrowings) to make external payments, which was called the ‘budgetary problem’.
While Keynes agreed that the ‘budgetary problem’ could be solved he was unable to grasp how note issue banks worked and insisted that there was a ‘transfer problem’, which required an export surplus.
Economists including Bertil Ohlin and Jacques Rueff pointed out that there was no “transfer problem” but it was a crisis linked to inflationism of the central bank.
Austrian economic doctrine which helped create the Deutsche Mark and German Economic Miracle after World War II.
German liberal politicians including Ludwig Erhard, closed the inflationist Reichsbank and kept tight hold of money, while the war-winning UK was mired in Sterling crises due to Keynesianism and the policy rate and ended up with 11 IMF programs.
Spread of Inflationist Policy Rate
By the inflationist doctrines were widely taught in UK and US universities, backed up by various mathematical formulae, rejecting economic principles, ultimately leading to the collapse of the US dollar in 1971 and the Great Inflation that followed.
In the 1970s, the Bank of England was the top borrower from the IMF and a top user of central bank swaps, which were also invented by the Fed.
The UK ended exchange controls only after Margarat Thatcher became Prime Minister, who was advised by Austrian economist Friedrich Hayek, among others.
The inflationist beliefs also formed the foundation of the Bretton Woods and the International Monetary Fund, where capital controls were taken as a given.
There was a belief that reserves could be ‘loaned’ to countries with bad central banks which mis-targeted rates to boost growth or for any other purpose such as sterilizing interventions.
However, Sri Lanka’s central bank has maintained monetary stability and also allowed the exchange rate to appreciate giving tangible benefits to the people over 2023 and so far in 2024, even as large external payments were made.
Maintaining exchange rate (and balance of payments) stability, which involves sequencing external payments to domestic investments through a market driven interest rate is a simple matter as long as politicians are willing to bring laws against macro-economists to curtail ‘macro-economic policy’, analysts say.
After debt is restructured in Sri Lanka in 2024, foreign inflows to the government resumes, the financial account could turn positive and the current account into deficit, analysts say.
Estimates of current and financial (and capital account) are approximated totals, subject to errors and omissions, but the balance of payments surplus or deficit, which is linked to developments in the central bank’s balance sheet, is verifiable data. (Colombo/Apri24/2024)