ECONOMYNEXT - A mystery surrounding a monetary bombshell unleashed on the credit system at the turn of the year deepened with Central Bank Governor Indrajit Coomaraswamy also unable to fully shed light on the toxic move.
On January 02, Sri Lanka had to roll-over an estimated 119 billion rupees of bonds and interest coupons. This included 72 billion rupees of a bond maturing on 01.01.2017 and the balance included interest payments falling due from other maturities.
But the government only offered for auction 57 billion rupees of bonds accepted bids for of 55 billion rupees, leaving a balance of about 64 billion rupees to be financed through other means.
On January 02, net excess liquidity in the banking system rocketed by 68 billion rupees to 108 billion rupees, from 39 billion rupees on December 30, indicating that a massive volume of money had been printed and let loose, flooding the banking system to the brim.
Printed money boosts domestic credit and drives imports pressuring the exchange rate down and making it difficult to collect reserves or generating forex reserve losses, when the exchange rate is defended in addition to driving up inflation.
"It was to help the government with a cash flow problem," Governor Coomaraswamy responded to reporters.
The central bank's Treasury bill stock initially which was at 219 billion on December 29 due to the money printed to generate the 2015/2016 balance of payments crisis shot up to 330 billion rupees on December 30, without a commensurate increase in excess liquidity on that date.
Such an event could indicate that a foreign loan had been repaid through a reserve appropriation or that the liquidity generated had been cancelled against past provisional advances to given to the government or a combination of both.
The 108 billion rupees of liquidity flooded into the banking system on January 02. On January 03 excess liquidity rose to 121 billion rupees, which was equal to about 18 percent of the monetary base at the time.
Governor Coomaraswamy said the problem with state debt was one of the reasons for the most recent policy rate increase to 8.75 percent with the monetary base (reserve money) expanding fast.
Governor Coomaraswamy declined a request to explain further, indicating that fiscal dominance of monetary policy has been involved, analysts say.
"Well. There is an advance account…," Governor Coomaraswamy said. "I tell you what. This one you should ask the Treasury. Better to ask the Treasury."
The central bank subsequently sold down Treasury bills and progressively mopped up liquidity, in a bid to reverse the damage done to the credit system, before all of the newly minted cash hit the forex markets.
Reporters questioned whether the deadly action was monetary policy.
"No that was not policy," Coomaraswamy confirmed. "That was a particular cash flow issue that came.
He said the central bank was able to reverse the effect.
It was over five weeks when the liquidity became neutral. And part of the liquidity was lost through peg defence.
Treasury bill yields also picked up as the bonds taken to the balance sheet to repay the bonds were sold down.
Analysts say effectively the government may have shaved a few basis points off longer term bonds and flattened the yield curve by repaying part of the bonds with printed money.
Sri Lanka had raised unusually low amounts of cash via Treasury bills during the current balance of payments crises, creating an anomaly in the short end of the yield curve.
By issuing Treasury bills to the market at higher rates (instead of bonds) and shortening the tenor of maturing debt, the government could have achieved the same result, without adding excess demand to the economy and losing forex reserves by printing money, some analysts say.
Economists and analysts have warned earlier that a core problem is lack of monetary independence which allows the Treasury to force the central bank to print money (fiscal dominance), undermine the currency and generate inflation.
Sri Lanka's BOP crises, currency troubles, and high inflation is generally caused by budget deficits being accommodated through central bank credit, sometimes willingly.
There have also been calls for the central bank to be abolished and a fixed exchange rate re-built so that a hard budget contestant is placed on free spending politicians, who practise economic deception on an unknowing public with printed money.
Even if budget deficits fall, accommodation of debt repayments with central bank credit will have similar de-stabilizing effects, unless rates are so high that that private credit collapses, analysts warn.
Governor Coomaraswamy said the bunching up of debt is going to be addressed in the future with a fixed calendar of bond auctions spread more evenly.
But in 2017 was there a likelihood for further liquidity bombshells going off?
"I hope not," Governor Coomaraswamy said. (Colombo/Mar30/2017)
The full discussion at the last post monetary policy media briefing is reproduced below:
Q: Governor can you explain what you said about bunching up of debt and central bank going to accommodate it?
A: No, no. There are two things. One thing is we are thing address the bunching of issuance by having an annual auction calendar whereby every month on a particular day a specific amount will be raised
So everybody will know what the annual auction calendar is, how much will be raised, on what day of the month. That is the kind of auction calendar we are trying to move towards to address the bunching up.
May be this is what you meant,…because there is this heavy government borrowing requirement, through this bunching of mobilization of debt in the first half of the year, the central bank had taken some of the government paper.
The Treasury bill holding of the central bank is now about 230 billion. (For me) personally.. it is not a happy level. We need to bring it down.
That is also one of the reasons that went into this interest rate increase. Because the monetary base is expanding.
But … the reality is in the first half of the year the government needs a lot of money. And we are trying to mobilize as much as possible through the auctions, and I hope the central bank won't have to make any …(inaudible).
But we are trying to get to a system where the claim on the central bank government paper will become much less by having an auction system which will have a capacity to raise money on the hand and if at the same time the deficit keeps coming down, then the requirement will also come down. So we are trying to operate at both ends.
Q: This was not a problem in the past. In the sense you were never required to finance the repayment of the bond auctions.
A: No, no, we are not taking on bonds.
Q: I mean even if you pass it through the bills and repay bonds or whatever, this was never question in the past.
A: In the past also the central bank has taken on some debt.
Q: Yes. But which had always led to crises. I think something happened in January. Can you explain what happened? There is some question of what happened on December 31 and January 02. Can you explain? I mean did you do it as a matter of policy? Is it something…?
A: It was to help the government with a cash flow problem.
Q: What happened exactly?
A: Well. There is an advance account… I'll tell you what. This one you should ask the Treasury. Better to ask the Treasury.
Q: But you did it.
A: We helped them to do it.
Q: Are you saying seriously that….?
A: No that was not policy. That was a particular cashflow issue that came…(inaudible)…which we were able to reverse.
Q: Yes we saw the data when you tried to sell it down with auctions and so on.
A: It eventually had a neutral effect….
Q: But after January 02 it was not a neutral effect. We saw the liquidity going up, when they paid the bonds. Are you telling me that this can happen again?>
A: I hope not. … (inaudible) .As I said these kinds of problems will get ameliorated as he government budget improves …(inaudible)….
Q: In most countries with stable economies central banks do not have to do this kind of thing. How is it that the central bank is doing this? Do you need change to the monetary law? If you do this all your rate hikes will get undermined…?
A: As I said that was a one of thing. We are now trying to create an auction calendar.