Sri Lanka sees more foreign interest in rupee bonds

ECONOMYNEXT – Sri Lanka saw a recovery in interest on rupee-denominated foreign bonds as interest rates rose and domestic credit slowed, reducing foreign exchange outflows.

Foreign investors’ holdings of rupee bonds increased from 4.01 billion rupees on August 31, 2022 to 22.5 billion rupees on October 05.

The bonds were bought despite the threat of a second haircut or a restructuring of the rupee bonds.

Rupee bonds have already been subject to high inflation and financial repression (IFR), with their real value nearly halving as the rupee’s loose peg to the US dollar collapsed from 180 to 360 against the US dollar.

Domestic inflation reached 70% in the 12 months to August.

Foreign holdings of Sri Lankan rupee bonds are now at levels last seen in June 2020.

Foreign investors held large volumes of rupee bonds before the rupee began rapidly collapsing under ‘flexible inflation targeting’, perhaps the most deadly ‘impossible trinity’ style monetary regime ever concocted by Washington-based mercantilists.

Flexible inflation targeting involves the application of aggressive open market operations to suppress interest rates with money printed on a collecting reserve, triggering currency crises.

Critics have said that such schemes, which are an extreme example of the impossible trinity of monetary policy goals, are easily sold to Third World countries without a solid doctrinal foundation in sound money or classical monetary theory.

A World Bank survey showed that there was no such doctrinal basis in the entire South Asian region, and only 2% of “experts” knew that balance of payments deficits were caused by central banks, indicating that the region would continue to struggle with currency instability for the coming year.

Washington-based mercantilists, including Harry Dexter White and John H Williams, were the first to concoct the Bretton Woods system by promising “independent monetary policy” to central banks pegged to the US dollar.

To be fair, however, the Bretton Woods central banks were also independently pegged to gold and were free to pursue policies aimed at maintaining the peg to gold, which has been done by countries like the United States. Germany and Japan which managed to maintain their anchorage and Germany appreciated once.

In Sri Lanka, the rupiah was dismantled by several types of open market operations under a fully discretionary policy available under flexible inflation targeting.

From 2015 to 2019, the rupiah fell from 131 to 182 due to mistargeting of rates by the termination of forward repo agreements that had stemmed liquidity earlier when domestic credit was weak, repo auctions futures, day-to-day liquidity injections and outright bond purchases.

Other tools to inject cash included a so-called ‘buffer strategy’ where bonds were redeemed with bank overdrafts refinanced with printed money and in 2018 by injecting rupee-to-dollar swaps of the style used to create liquidity and break the East Asian peg in 1997.

Starting in early 2020, as interest rates started to rise after the tax cut, a plethora of liquidity tools were unleashed.

Rupees were pumped in through injections made to force rate cuts, reserve ratio cuts and finally the deadliest tool of controlling prices to cripple bond auctions.

Any errors of mistargeting rates are offset by currency depreciation through a “flexible exchange rate,” triggering social unrest and malnutrition.

The rupee went from 182 to 360 per US dollar from 2020 to 2022. (Colombo/Oct05/2022)

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