Tuesday May 21, 2019

Sri Lanka injects Rs123bn to sterilize dollar outflows

Oct 01, 2018 13:48 PM GMT+0530 | 0 Comment(s)

MOPPING FAILURE:  Many term repo auctions in February failed as credit picked up and rates rose in a new credit cycle.

ECONOMYNEXT - Sri Lanka's central bank has injected around 123.21 billion rupees (about 730 million US dollars) to sterilize dollar outflows below the ceiling policy rate, in the second currency panic triggered by targeting dual anchors in 2018.

Up to Friday the central bank injected 118.2 billion rupees net after deducting 5.05 billion rupees kept overnight by excess banks in the deposit window.

About 90.6 billion rupees were injected via 7 day and 14 day term reverse repo auctions, at rates as low as 8.07 percent despite having a 8.50 percent ceiling rate to protect the currency peg.

Another 19.57 billion rupees were injected overnight Friday at rates as low as 8.07. Banks also borrowed 32.54 billion rupees from the last minute window at 8.50 percent.

On Monday 21 billion rupees were injected overnight at an average of 8.19 percent, and 10 billion rupees was injected at an average of 8.29 percent for 7-days. Overnight window borrowings happen later in the day.

Sri Lanka rupee collapsed twice in 2018 after the central bank tried to operate a 'flexible exchange rate' after injecting and maintaining unsterilized excess liquidity of tens of billions of rupees through domestic or foreign asset purchases.

In the first quarter of 2018 the central bank ran out of Treasury bills to permanently sterilize liquidity from dollar purchases. The central bank operates a peg to build foreign reserves under an agreement with the International Monetary Fund.  (Sri Lanka's central bank caught between peg and a hard place)

In December, there were calls for central bank to start issuing central bank securities again in order to be able to collect foreign reserves as signs were emerging that a new credit cycle was beginning, (Sri Lanka's Central Bank should sell own securities in new credit cycle: Bellwether), given its past tendency to run printing presses at the drop of a hat.

The central bank unsuccessfully tried to sterilize liquidity through term repos in February at rates close to the floor of the policy corridor, and in March, terminated whatever term repos that were in place, without rolling over, to inject liquidity as credit demand picked up, and keep rates down.

In April, rates were cut and  tens of billions of rupees were injected to keep rates down and maintain excess liquidity in the middle of a so-called 'buffer' strategy.

The first run on the rupee for the year was triggered by trying to operate a 'flexible exchange rate' by not intervening despite the existence of excess liquidity, critics say.

The rupee fell from 155.50 to the US dollar in the first week of April, to 159 to the US dollar in the first run. Credibility was built at around 160 to 161 to the US dollar.

The central bank then built up excess liquidity with swaps (effectively pegging) and again did a 'flexible exchange rate', with excess liquidity remaining in the system, switching regimes suddenly.

The second run has so far taken the rupee to around 170 to the US dollar.
Up to Friday, the central bank has operated more prudent monetary policy for 9-days by keeping overnight money markets short (injecting only overnight cash) up to about 30 billion rupees or more.

Injecting cash through short-term reverse repo deals also forces banks to find deposits (curtailing consumption), or curtail credit or both, reducing pressure on the currency rather than buying Treasury bills outright as in previous crises.

The IMF had also given a flawed program to the central bank involving pegging (collecting reserves) or an external anchor, and created the false impression that rates can be cut if inflation is low (domestic anchor or inflation target), despite operating a pegged system. This was the original false promise of Bretton Woods system of failed soft-pegs (independent monetary policy).

The inflation target is also too wide for exchange rate stability, analysts pointed out. (Sri Lanka needs narrower inflation target to stop stagflation, BOP crises)

While calling for a 'flexible exchange rate' the IMF - at least publicly - does not make a distinction between sterilized and unsterilized peg defence, which may also be contributing to the current spate of monetary instability. While unsterilized defence is effective, sterilized defence is not.

Recent large liquidity shortages coincided with a 750 million dollar bond repayment falling due at state-run National Savings Bank.

However currency pressure began before that.

Analysts and economists have pointed out that Sri Lanka's central bank has to be overhauled to end the pursuit of contradictory dual anchors (soft-peg) if the country is to progress, prevent people from falling into poverty and have freer trade. (The problem with Sri Lanka's dual anchors)

Autarkists have already started blaming free trade for Sri Lanka's monetary instability.

Over the weekend, the Finance Ministry also jumped on the bandwagon and slapped Mercantilist, Nixon-shock style import controls giving real-economy remedies to a problem involving monetary instability. (Colombo/Oct01/2018)


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