A shocking revelation: Sri Lanka's forex inflows reached a staggering $2.3 trillion in September, but here's the catch - imports surged to an unprecedented $2.0 trillion! This economic anomaly has sparked a heated debate among experts and left many scratching their heads.
In a recent report, Sri Lanka's central bank revealed an intriguing trend. Despite recording an external 'current account' deficit for the first time this year in September, the bank managed to purchase a substantial amount of dollars from the public. This raises questions about the true nature of these deficits and their impact on the country's economy.
The Controversial Role of Central Banks
Post-World War II, central banks have often been blamed for forex shortages and currency depreciation, conveniently pointing fingers at 'current account deficits'. However, this perspective is a throwback to the classical Mercantilist belief that trade deficits are solely responsible for monetary depreciation. Modern economists argue that the operating framework of central banks plays a crucial role, yet these institutions often operate with little accountability to the public or parliament.
Unaccountable Central Banks: A Recipe for Disaster?
Critics argue that modern central banks, especially independent ones, are unaccountable and unrestrained by the laws that governed their classical counterparts. This lack of oversight can lead to errors in monetary policy, as seen in the case of Sri Lanka. The imposition of exchange controls, a key tool of unaccountability, restricts the economic freedoms of citizens and covers up operational errors.
The UK's Post-War Experience: A Cautionary Tale
The UK, after nationalizing the Bank of England in 1947, imposed peacetime exchange controls under a full employment policy. This aggressive approach led to a massive collapse of the Sterling in 1949, a premier global currency at the time. Sri Lanka's current account deficits and surpluses have resulted in currency depreciation under a 'flexible' exchange rate policy, a hallmark of central bank unaccountability.
The Impact of Inflationary Operations
Inflationary operations by central banks can trigger social unrest and higher inflation in food and energy prices. Sri Lanka's central bank has temporarily suspended such operations, but the coupons on its bond portfolio remain deflationary. This could potentially lead to an overall balance of payments surplus, depending on the impact of inflationary swaps.
The Role of Deflationary Policy
Under deflationary policy, the central bank has the power to either depreciate or appreciate the currency through exchange rate policy. By buying or selling dollars, the bank can influence the currency's value. Interestingly, the central bank has sold some dollars purchased in 2025 to the Treasury to settle debt, a move that is deflationary in nature.
The Threat of Default: A Looming Crisis?
Despite adopting a broadly deflationary policy, Sri Lanka's central bank has missed its 5% inflation target. Experts warn that unless the central bank is required to sell its Treasury bond stock in the next IMF program or the Treasury is granted the freedom to buy dollars, a second default could be imminent. This highlights the delicate balance between monetary policy and economic stability.
And this is the part most people miss - the intricate dance between central bank operations, inflation, and economic freedom. What do you think? Is the current account deficit truly to blame, or is it a symptom of a deeper issue? Share your thoughts in the comments!
