India top lender to Sri Lanka in 2022

India has disbursed or agreed to give Sri Lanka 1.55 billion US dollars in 2022 to make imports, as the country went through the worst currency crisis in the history of the island’s central bank, official data show.

By September 855 million dollars had been disbursed. The amount does not include delayed payments under the Asian Clearing Union.

Sri Lanka had signed 8 foreign financing agreements totaling 1.87 billion US dollars up to September 2022.

Exim Bank of India had given a 500 million US dollar facility to import oil, a 50 million dollar credit facility for Urea and the State Bank of India had agreed to give one billion US dollars to import commodities.

The money repaid by the importers can be used for budget finance.

From around 2015 Sri Lanka ran into extended monetary instability under so-called ‘flexible inflation targeting’ where money was printed to suppress rates, delay rate hikes, create forex shortages and break a currency peg using inflation lags and core inflation indices.

As serial currency crises emerged large volumes of money was borrowed from capital markets and China through bonds and syndicated loans, leading a steep rise in external debt while foreign reserves were run down.

The IMF gave technical assistance to the central bank to calculate an output target, diverting it from goal of maintaining economic stability and giving clues to chase an output gap, which was not permitted under its constitution (Section 5 (a) according to people who helped draw up the law.

In Sri Lanka, monetary instability loans are called ‘bridging finance’. Singapore Prime Minister Lee Kwan Yew had called foreign borrowing made after a central bank creates forex shortage ‘cover up loans’.

“If you start fiddling around with currency and you start printing notes and then you have no money really to spend and you start borrowing to cover up, you will end up in penury and bitterness,” Prime Minister Lee said on August 26, 1966.

“Tomorrow, you will hear from the Minister for Finance that we have decided that we shall not form a Central Bank. If we cannot reach a common currency with Malaya, we shall run a Currency Board as the British did for many decades.”

Asian Development Bank had given as 200 million US dollar loan for ‘food security’.

US had given a 65 million dollars grant.

Up to September 1.9 billion US dollars had been disbursed with India giving 855 million US dollars.

India had separately deferred payments under the Asian clearing union in 2022 allowing Sri Lanka’s soft-pegged central bank to intervene for private sector imports and print money to keep its policy rate down and expand a balance of payments deficit.

A soft-pegged central bank which uses reserves for imports, then prints money to prevent bank rupee reserves from adjusting down and the economy from being adjusted to the outflows.

After the ACU credits stopped, the central bank lost the ability to create BOP deficits.

Post 1931 central bank using an ideology propagated in several US and UK universities (lost-generation economics), which rejects the classical monetary principles, trigger severe external imbalances until rates suddenly skyrocket and the peg collapses.