ECONOMYNEXT – The International Monetary Fund, in a report on how to print money to target a single policy rate, has also brought dedollarization politics to fore, though there is no demand from the public to undermine foreign currency deposit accounts.
Dedollarization has not been on the agenda of the recent election or any other elections in Sri Lanka up to now.
De-dollarization Agenda
“The CBSL should introduce SRR for FX liabilities for macroprudential objective as part of a comprehensive framework aimed at dedollarization and promoting its own currency,” the IMF technical report on liquidity operations to maintain a ‘single policy rate’ said.
Sri Lankans were given the freedom to have dollar bank accounts (deposit dollarization) by political leaders in 1979 as part of an opening of the economy from the draconian import and exchange controls that crippled the economy due to central bank’s liquidity injections.
Initially the freedom was only given for foreign employed persons (NRFC accounts), they were then allowed for residents.
People started to maintain dollar accounts especially in the 1980s as the domestic currency issued by the central bank started to collapse against the US dollar, after the IMF’s Second Amendment left the agency without a credible anchor for money.
At the time the central bank also engaged in re-financing rural credit with printed money in addition to sterilizing interventions in the forex markets.
In the 1980s Sri Lanka suffered greater inflation than the ‘Great Inflation’ of the 1970s that the US and UK and Sri Lanka suffered in the 1970s after the Fed’s single policy rate triggered the collapse of the gold standard following aggressive macro-economic policy of the 1960s to push ’employment’.
Bad central banks use de jure or de facto ‘legal tender’ legislation to force the public to use their inflating, depreciating money and prevent them from moving to a better money to maintain monetary stability, and protect their savings and salaries.
Results of Monetary Policy
When the currency depreciates, due to what is loosely referred to as ‘monetary policy’, food and energy prices go up, destroying the value of wage earners in particular, making it difficult for those in marginal income brackets to eat, driving large sections of the population into poverty.
Meanwhile, lifetime financial savings in bank accounts of others also lose their value.
Capital flight is also triggered as people lose confidence in the currency of the money monopoly which is suppressing the policy rate with liquidity operations including by sterilizing interventions. Parallel exchange rate also develops as ‘monetary policy’ continues.
To restore confidence in the currency, which was lost due to the policy rate, economic activity and private credit has to be smashed with excessively high rates, in a ‘stabilization crisis’.
The government under which rates were cut (currency crisis), is defeated in the hands of the electorate and the administration that rules during the stabilization crisis, could also lose power, especially if the currency continues to depreciate, as they did after 1978.
Only authoritarian administrations can survive under repeated inflation and currency crises.
In the 1980s, rigging of elections became common, after the IMF’s Second Amendment led to high inflation and depreciation.
The IMF report said statutory reserve ratios for foreign currency accounts should be brought back.
Higher than prudential dollar SRR’s to support IMF dedollarization agenda?
“The CBSL previously abolished a SRR for FX liabilities to support liquidity of the banking system,” the IMF report said.
“Currently, the open currency position of state-owned banks is likely to be negative, but an improved situation in the financial system will allow banks to allocate enough FX liquidity to fulfill SRR in foreign currency.”
Sri Lanka lost all foreign reserves and the central bank borrowed dollars, spent them and sterilized the sale with new money to suppress policy rates in the process of triggering and maintaining the last currency with low rates from 2020 to 2022.
Meanwhile the IMF report said the SRR for foreign currency should be higher than for rupee, not for any prudential purposes, but to meet a political agenda to ‘dedollarize’.
“There are no exact rules to set the appropriate level of SRR for foreign currency, but it is usually higher than for SRR for local currency to disincentivize the usage of foreign currency,” the report claimed.
The IMF is pushing dedollarization as well as ‘monetary policy modernization’ which usually involves transplanting innovative ways to print money developed in Western central banks with free floating regime to reserve collecting regimes in unfortunate countries.
Cambodia which has been free of macroeconomic policy and economic crisis for over 20 years after the central bankers the ‘transmission mechanism’ of the Riel to trigger forex shortages and currency collapses and no takers for its printed money and weak liquidity tools in any case.
Monetary Policy Modernization; new tools to print money
But the IMF proposed new ways to print money into banks by “modernizing monetary policy framework together with dedollarization”.
“Developing market-based monetary policy tools, including an Interest Rate Corridor (IRC), would support the NBC’s policy agenda to modernize monetary policy framework and enhance the use of the national currency,” the article IV Consultation report said.
The IMF also suggested an interest rate corridor (IRC) to replace the Marginal Lending Facility (essentially a single policy rate).
“In addition to the MLF which serves as ceiling rates, the full-fledged IRC requires introducing an overnight deposit facility that serves as a floor for short-term KHR market interest rates.
“The NBC is currently reviewing operational issues as pre-step to introduce overnight deposit facility.”
The IMF also proposed breaking the exchange rate peg which has helped make the country an oasis of stability and proposing Sri Lanka style inflation targeting without a floating regime.
“The central bank, supported by capacity development assistance from the Fund, is working to improve key aspects of monetary policy and FX operations, with the goal to move from a de facto exchange rate targeting framework to a more direct targeting of inflation,” the IMF report said.
Insidious Technical Assistance
IMF technical assistance on hidden ways (and reasons) to print money comes through the central bank and people wake up about 8-10 years later when they cannot eat property and kick out the incumbent government.
It took about 8 years from the invention of open market operations to the Great Depression. It took even less year for the policy rate to spread from them and for ‘beggar thy neighbour’ policies and protectionism to run haywire in the 1930s.
The first meeting was however done (in the absence of New York Fed Governor Benjamin Strong) to mop up liquidity not to inject and create instability and political upheavals as in later years.
It took about 10 years for full employment policies and OMO to smash the Bretton Woods. It took 8 years of reflation by Greenspan-Bernanke to blow the housing bubble and start the Great Recession that came in its wake.
The IMF gave Sri Lanka technical assistance to calculate ‘potential output’ encouraging the printing money for growth in a country without a war around 2015.
As a result, Sri Lanka went into a series of rapid-fire currency and stabilization crises after despite having peace, triggering social unrest and political instability as well as sovereign default in 2022.
To its credit Sri Lanka’s central bank has never engaged in dedollarization politics in the past,
It has progressively relaxed forex controls volumes of personal possession of foreign currency and especially in the 1990s relaxed rules of deposit dollarization and also capital transfers after ending re-financing credit and allowing market determined interest rates ending financial repression in general.
However from around 2015 large volumes of money were printed to target the average call money rate, negating all the benefit of market determining government securities through the transmission mechanism where a ‘bills only; policy was also violated.
After a combination of flexible inflation targeting/potential output targeting with aggressive targeting of the average weighted call money rate, Sri Lanka tightened many exchange controls including the outward remittances from dollar accounts.
Until now with banks unable to give loans without deposits, lack of standing facilities and other tools to lend money without deposits Cambodia’s banks have been prudent and well capitalized.
In Sri Lanka as in Cambodia, there is nothing the people, elected rulers can do against the transmission mechanism, policy rate driven instability.
Elected politicians, parliament and democracy itself are mere playthings at the hands of an independent or non-independent central bank that answers to IMF ‘monetary policy modernization’ which are arcane techniques to print money and mis-target rates.
It will be interesting to see how long it will take for IMF’s ‘technical advice’ including de-dollarization,’ abandoning the exchange rate targeting framework to turn Cambodia into a Sri Lanka.
Based on past experience it usually takes 8 to 10 years from IMF ‘technical assistance’ being put into practice. (Colombo/Oct06/2024)