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Sri Lanka's Central Bank Strengthens Forex Reserves Amid Economic Recovery

2024-11-10 04:39:36.367000

Sri Lanka's economy is currently grappling with significant challenges, as the rupee opened weaker at 296.60/297.20 to the US dollar on October 3, 2024, down from 296.40/80 the previous day [046aa34d]. This depreciation is compounded by rising bond yields, with a bond maturing on December 15, 2027 quoted at 11.35/50 percent, an increase from 11.15/30 percent [046aa34d].

In September 2024, Sri Lanka's trade deficit widened to 634 million USD, up from 429 million USD in August, as imports totaled 1,645 million USD, slightly down from 1,654 million USD, while exports dropped significantly from 1,224 million USD to 1,011 million USD [de55d186]. The services surplus also fell sharply to 156 million USD from 287 million USD, indicating a decline in economic activity in this sector [de55d186]. Remittances decreased to 555.6 million USD, further straining the economy [de55d186].

Despite these currency fluctuations, the stock market showed slight resilience, with the All Share Price Index rising by 0.07 percent to 11,942 and the S&P SL20 increasing by 0.08 percent to 3,512 [046aa34d]. Market turnover was reported at 74 million rupees, indicating ongoing trading activity [046aa34d].

In October 2024, Sri Lanka's central bank purchased 189.5 million USD from forex markets, a significant increase from 96 million USD in September [93cc982c]. This move is part of the central bank's broadly deflationary policy implemented since late 2022, which has led to balance of payments surpluses and an appreciation of the exchange rate, resulting in falling consumer prices and higher disposable incomes [93cc982c]. However, concerns have been raised over potential policy errors reminiscent of past economic crises in 2015 and 2018 due to open market operations [93cc982c].

As of September 2024, Sri Lanka's gross official reserves increased by 38 million USD to 5.992 billion USD, as the central bank purchased 108.5 million USD and sold 12.5 million USD in the interbank foreign exchange market [3d73a916]. The reserves include monetary reserves and fiscal reserves from foreign borrowings, as the central bank continues to repay debts to the IMF and the Reserve Bank of India [3d73a916].

As of Q2 2024, Sri Lanka's banks have built foreign currency balances to US$3.7 billion amid the ongoing currency crisis, although these balances peaked at over US$4 billion in Q3 2023 [5ce3deda]. The banks have also repaid government dollar borrowings in rupees as part of a broader debt restructuring effort, contributing to a total of US$7.4 billion in reserves or debt repaid since the country defaulted in April 2022 [5ce3deda].

Since April 2022, the banking system has repaid debt or built foreign exchange reserves totaling approximately 7.39 billion USD [fd30b27a]. The central bank's efforts to combat inflation included hiking rates in April 2022, leading to a selective default on bilateral and commercial debt while continuing to meet multilateral debt obligations [fd30b27a]. From April 2022 to August 2024, the central bank collected or repaid 3.9 billion USD, while banks contributed 3.4 billion USD to this effort [fd30b27a]. Currently, banks are also depositing dollars abroad, reflecting a cautious approach to managing foreign reserves [fd30b27a].

A recent IMF report has introduced the concept of dedollarization politics in Sri Lanka, highlighting that dedollarization has not been a public demand or part of recent elections [2da686a4]. The report suggests that the Central Bank of Sri Lanka (CBSL) should introduce statutory reserve ratios (SRR) for foreign currency liabilities to promote dedollarization. Since 1979, Sri Lanka has allowed dollar bank accounts, and the severe inflation experienced in the 1980s led to significant currency depreciation [2da686a4]. Critics argue that the IMF's dedollarizing agenda threatens economic freedom, while former President Ranil Wickremesinghe emphasizes the need for experienced parliament members to address the economic challenges [5ce3deda].

The IMF's recommendations include modernizing monetary policy and breaking exchange rate pegs, as past assistance from the IMF has often led to economic crises in Sri Lanka. The report warns of potential political instability stemming from these economic policies [2da686a4]. The Ceylon Chamber of Commerce has expressed support for the IMF's debt restructuring efforts, indicating a collaborative approach to addressing the nation's economic challenges [2da686a4].

Earlier reports indicated that the Sri Lankan rupee had shown some strength, trading at 299.80/300.00 to the US dollar on September 27, 2024, but recent fluctuations highlight the ongoing challenges faced by the economy [d704aeb1]. The Central Bank of Sri Lanka has maintained its policy rates between 8.25 to 9.25 percent, projecting inflation to remain below 5 percent, which is a positive sign for economic stability [d704aeb1]. Analysts caution about potential inflation with new laws allowing for 5-7% inflation targeting, despite the overall improvement in growth as monetary stability is restored [3d73a916]. Additionally, the number of active credit cards in Sri Lanka rose by 0.5% to 1,928,378 by August 2024, indicating signs of economic recovery [3d73a916].

As Sri Lanka navigates these economic challenges, the combination of internal reforms, external support, and the implications of dedollarization will be crucial in determining the trajectory of its recovery. The recent rise in net profits for Sri Lanka's Hemas Holdings by 23.7 percent in response to a strong rupee and declining global commodity prices further illustrates the complex dynamics at play in the economy [93cc982c].

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