ECONOMYNEXT - Liquidity shortages rose to 57 billion rupees on Tuesday from 41 billion rupees a day earlier, pointing to heavy forex interventions to strengthen the rupee as money printing boosted imports and weakened the currency.
The liquidity shortage was filled or sterilized with overnight cash injections with banks and primary dealers borrowing a record 79 billion rupees in printed money overnight, pointing the way for further forex reserve losses and monetary instability.
Banks and primary dealers borrowed 50 billion rupees from an overnight reverse repurchase cash auction at 7.98 percent while others borrowed another 29.66 billion rupees from the overnight discount window.
Among the primary dealers who are borrowing from the printed money at 8.0 percent are those who bought 2030 bonds at yields as high as 14.80 percent.
In the past the Central Bank used to print money by purchasing Treasury bills outright as it does not buy bonds as a prudential measure.
Ironically now primary dealers who bought long bond and loaned money to the government at over 14.00 percent are now financing their bids with 8.0 percent printed money.
After the rupee weakened to almost 150 rupees, authorities renewed interventions, amid fears of renewed fiscal dominance.
A state bank which usually acts for the authorities has been seen selling dollars at 144.50 to the US dollar. When dollars held by the central bank are sold, excess rupees are 'mopped up' (unsterilized forex sale) which tends to push up rates and slow domestic credit.
But the central bank by injecting new cash (sterilized foreign exchange sale) to maintain policy rates at 8.0 percent, generates more monetary stability, by trying to simultaneously trying to control both exchange and interest rates, which is not practical in real life.
EconomyNext's policy columnist Bellwether has warned that the International Monetary Fund is likely to seek a float of the currency to end the vicious cycle of interventions and liquidity injections.
In April Sri Lanka's rupee usually tends to strengthen a little as credit slows and overseas resident workers remit money to loved ones at home. But when large volumes of money are printed and used up by the state, import demand can be boosted.
In April it is also customary in Sri Lanka to print some money to pay festival advances but there is also a seasonal cash demand (an increase in notes and coins in circulation) which tends to absorb most of the additional injections in a 'private sector sterilization' style process. (Colombo/Apr06/2016)