Sri Lanka’s cabinet of ministers had approved a 400 million US dollar swap line with the Reserve Bank of India, co-cabinet spokesman Minister Bandula Gunewardene said. Sri Lanka’s central bank will borrow the money from the RBI to boost its gross reserves.

Sri Lanka’s soft-currency peg with the US has come under pressure due to liquidity injections made by the central bank amid the Coronavirus crises.

Analysts had pointed out that risks of monetary stability went up during the tenure of ex-Governor Indrajit Coomarasway after a policy corridor was narrowed and a mid-rate started to be targeted with unlimited excess liquidity.

Sri Lanka’s rupee had been trading erratically with almost no premiums between spot and forward rates.

When liquidity is injected, a peg has to be defended with forex reserve losses. If the peg is not defended it will fall.

In general, when there is a weak credit currency pegs do not break. But in 2018 despite weak credit, liquidity injections hit the rupee.

Among South Asian central banks Sri Lanka’s central bank has the worst record falling to 195 to the US dollar from 4.70 to the dollar (the rate of the Indian rupee to which all of South Asia and parts of the Middle East was either pegged or ‘dollarized’ at independence.

The Maldives has had the most monetary stability on an absolute basis while Bhutan and Nepal monetary authorities have shown the most relative monetary stability since the end of British rule. (Colombo/Apr23/2020-sb)

https://economynext.com/sri-lanka-cabinet-approves-us400mn-currency-swap-with-from-india-67835/