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Sri Lanka banks borrow Rs64bn from liquidity window, rupee below 200 to the dollar

ECONOMYNEXT – Sri Lanka’s banks borrowed 64.6 billion rupees overnight on Wednesday up from 46 billion rupees a day earlier, keeping call money rates rock solid at 4.65 percent amid wide open taps, official data show as the rupee dipped below 200 to the US dollar.

In previous crises, liquidity shortages have been found mostly in state-run banks that finance the budget through overdrafts shorting reserves when they do not have deposits, analysts say.

State banks are also asked to subsidize losses at state energy enterprises, adding further pressure on the rupee.

The central bank’s holdings of Treasury bills are now at 842 billion rupees before the settlement of this week’s bill auction, not counting the overnight borrowings which put the bill stock at over 906 billion rupees. In Sri Lanka overnight window borrowings are collateralized, and deposits are not.

The overnight borrowings are highest since a 2018 currency crisis, which was triggered by open market operations (‘Go’ policy) and liquidity from Soros style swaps that had brought down pegs in East Asia in 1996 and 1997, despite gains tax revenues and the deficit, critics have said.

Stop-Go

Overnight borrowings were around 60 billion rupees in February 2020 when the markets were kept short in a corrective policy to halt a slide in the rupee, in the inevitable ‘Stop’ policies that follow ‘Stop-Go’ Keynesian stimulus.

In 2021 Sri Lanka is still in the ‘Go’ phase. Non-borrowed excess reserves rose to 167.1 billion rupees o March 31 from 148.5 billion rupees a day earlier banks which are plus liquidity.

Foreign banks and at least two large private banks are usually cash plus in Sri Lanka and are unable to contribute to balance of payments troubles that hit the soft-pegged rupee from time to time.

The rupee closed at 198.75/201.00 the one week dollar on March 31.

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When Modern Monetary Theory style injections began in 2020, the rupee was around 182 to the US dollar. Before a milder MMT version was carried out in 2018, the rupee was around 153 to the US dollar.

MMT is now being carried out through a combination of open market operations, outright purchases of Treasury bills and acquisitions of bills that fail to be sold under pre-set yield price ceilings.

Amid liquidity injections foreign reserves have steadily eroded, and forward dollar premiums have inverted, indicating that the forward rate is below the spot exchange rate. Banks have since been banned from giving forward cover to importers.

Earlier this week the central bank acquired 17 million dollars through a one month buy sell/swap at a negative premium of around 153 points, market participants said.

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Over 70 percent of bill auctions failed to be sold over the past two weeks, while foreign reserves are steadily eroding and imports are controlled.

Mercantilism

In Sri Lanka there is a strong Mercantilist belief that monetary instability is caused as trade with inflation cased by fuel (diesel in particular), balance of payments trouble (cars and gold) and currency falls (imports in general), rather than liquidity injections and failed Treasuries auctions.

Sri Lanka’s rupee fell amid liquidity injections in 2015 amid collapsing oil prices, in 2018 despite controlling cars and gold, in 2020 despite the worst import controls seen since the 1970s where wholesale T-bill auctions also took place.

“The Treasury had to finance its expenditures increasingly by resort to Treasury bills despite the fact that no significant tenders forthcoming to absorb the successive issues of Treasury bills,” an unknown classical economist inside the central bank wrote in the agency’s 1975 anniversary publication.

“The responsibility of absorbing the unsubscribed portion of the Treasury bill issue fell on the central bank.

“A major drawback in financing of budget deficits with central bank credit is that while the process involves an expansion in the money supply, it is not necessarily accompanied by an expansion by a corresponding increase in national product.

“Consequently, increased demand emanating from central bank financing of budget deficits had to be satisfied by increased recourse to foreign supplies with resulting pressure on the country’s external payments.

“Thus, though the Government fiscal problem and the balance of payments deficits were two distinct problems, they were nevertheless inter-related, in that the balance of payments deficits and loss of external assets arose partly out of the method by which the government sought to finance its deficits.

“With the continued loss of reserves and the accumulation of external liabilities, the ability of the Central Bank to maintain the international value of the rupee was gradually undermined.”

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