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ECONOMYNEXT – Sri Lanka is projected to lend 2,533 million US dollars mainly to the US and Euro areas during an International Monetary Fund deal in 2023 including a mandatory 1.4 billion US dollars collected from exports and remittances, according to official documents.

Sri Lanka is expected to get two tranches of 331.2 million dollar (254 million special drawing rights each) in March and September 2023 from the IMF.

In 2023 Sri Lanka has to repay 256.4 million dollars from an earlier IMF loan taken during an earlier currency crisis triggered by inflationary open market operations to target artificially low policy rates under flexible inflation targeting.

Net inflows from the IMF would be 406.12 million US dollars in 2023 if the first review is completed in September 2023.

Sri Lanka has committed to collect at least 1.4 billion US dollars from remittances and exports and lend to the US and other developed nations during 2023 under the IMF deal.

A large volume has already been collected after a credit collapse and liquidity trap conditions in the domestic banking system, after a defined surrender rule which determined a transparent exchange peg was lifted.

An ad hoc peg is now operated under the IMF deal to buy dollars and export to the West, as ‘below-the-line outflows. Sri Lanka’s foreign reserves are usually loaned to highly rated sovereign or sovereign linked borrowers, mainly in the US.

But there have been amounts of Euro assets in Sri Lanka’s foreign reserves at times, triggering forex losses when the dollar to Euro parity changed.

Under the IMF program there is a performance criterion to increase net international reserves by 1,948 million dollars during 2023.

Sri Lanka is also expected to repay a 200 million US dollar swap to Bangladesh during 2023, which will also raise the NIR.

At the moment Sri Lanka’s central bank is in debt after borrowing from India, Bangladesh, India including on Asian Clearing Union dues as well as the IMF. Year end net international reserves would still be negative.

Sri Lanka’s gross reserves are expected to rise by 2.5 billion US dollars to 4.4 billion US dollars in 2023 indicating that the Indian Ocean island will lend 2.5 billion US dollars to the US and other highly rated borrowers. It may include re-invested interest coupons.

Sri Lanka is also expected to get 650 million dollars from the Asian Development Bank and 250 million dollars from the World Bank as part of partner support for the IMF deal. Outside of core monetary reserves linked to reserve money, balances in Treasury accounts are also counted as forex reserves.

A country can build reserves or repay loans – which are identical operations – long as there is a market interest rate to curtail domestic investment and consumption and there is no inflationary domestic operations by the central bank which are in conflict with the balance of payments to destroy the credibility of the peg.

Under the IMF program a new monetary law with overt money and exchange policy conflicts and legalizing inflationary open market operations for stimulus (output gap targeting) which critics had blamed for recent serial currency crises and default are to be legalized.

Though an intermediate regime central bank can maintain a strong exchange rate and collapse inflation and amid negative credit, under modern IMF programs due to conflicts coming from inflation targeting (the monetary policy consultation clause) currency crises come within programs.

A NIR target which is not complemented by falling ceiling on net domestic assets of the central bank can also lead to depreciation and inflation taxes on the poor, analysts have warned. (What Sri Lanka’s IMF program should look like).

The current program has a ceiling on domestic assets of the central bank but it is not downward sloping to complement the NIR target and maintain currency stability.

In the current IMF program, there is also a provision to use Fund credit for the budget after ‘converting rupees’, according to officials.

Questions by journalists whether the operation is likely to lead to changes in reserve money was not immediately answered by IMF officials.

IMF transactions in the past have been reserve-money-neutral and did not cause inflation or currency trouble.

In third world so-called ‘basket case countries’ with output gap targeting stimulus and inflationary open market operations, central banking is barely understood, critics say.

Monetary troubles in South Asia, Africa and the Middle East (outside of GCC pegged countries which have no money and exchange policy conflicts without active inflationary open market operations or a policy rate), is due to lack of knowledge of note issue banking, critics say.

Classical economists have pointed out that Western policy circles (mainly the US) lost the plot in the 1920 after John Maynard Keynes’ Economic Consequences of Peace which legitimized the activities of the Reichsbank after the First World War and the subsequent hyperinflation and default as a problem of the current account deficit and war obligations (the so-called ‘transfer problem’).

German (as well as Swedish and French) economists tried without success to change the return to mercantilism in US and UK official policy circles (at least one economist called it the ‘spurious monetary doctrines of the Allies’) but failed.

Sri Lanka also sought ‘bridging finance’ and borrowed heavily in recent years under similar conditions amid inflationary open market operations, critics have said.

After World War II, the German economists rejected the premise and built the new Deutsche Bank. The theoretical backing for the German monetary policy came from the Austrian economic tradition, including Wilhelm Ropke.

Sri Lanka has gone to the IMF 16 times, earlier mostly after targeting artificially low interest rates or operating re-financing schemes and getting into external trouble, which are then blamed on ‘budget deficits’ and has hardly learned anything, critics say.

A notable exception was the IMF Extended Credit Facility in 2003, under then-central bank Governor A S Jayewardene, probably one of two greatest economists in South Asia, who had knowledge of monetary policy, along with BR Shenoy of India analyst say.

It may perhaps be the only occasion when Sri Lanka entered an IMF deal when foreign reserves were climbing. (Colombo/Mar25/2023)

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