ECONOMYNEXT – Sri Lanka’s central bank has bought more than 20 billion rupees in bonds to inject new cash and target a call money rate, central bank officials said, amid a period of currency volatility.
“Now we have widened the scope of the open market operations to include some liquid bonds,” Central Bank Governor Indrajit Coomaraswamy said.
“In the past we focused on on the treasury bills. Now, some treasury bonds are also being used for open market operations the liquid ones.”
Sri Lanka’s central bank stopped buying bonds as part of reforms instituted by then Central Bank Governor A S Jayewardene, who ended chronic 20 percent inflation and chronic depreciation of the rupee.
Officials said about 20.3 billion rupees of bonds had been bought. However some bill had also been sold down since July.
Sri Lanka is recovering from a collapse of its so-called ‘flexible exchange rate’ in 2018, by liquidity shocks generated by the central bank apparently to target a call money rate.
Liquidity shocks were created by a combination of Treasury bills (open market operations), rupee dollar swaps similar to those used by speculators to hit East Asian currencies and unsterilized dollar purchases in the court of operating a strong-side convertibility undertaking of the soft-peg (flexible exchange rate)
Over recent years many reforms undertaken by Jayewardene were undone which analysts say have narrowed the time between currency crises.
One was the discontinuation of the issue of central bank securities which resulted in the next crises being triggered as soon the Treasury bill stock of the central bank bought to create the most recent crises was fully sold down.
The central bank maintained about a full year of stability in 2017, and started liquidity injections only around February 2018 to pressure the rupee.
However with Treasury bonds being bought to inject new money, before the existing stock of bills are sold down, the rupee has come under partial pressure without a full recovery of private credit.
Analysts have pointed out that the central bank followed prudent policies until July 2019, keeping short term rates above the market by withdrawing base money injected through a strong side convertibility undertaking of the peg.
However policy then suddenly reversed and new liquidity injections began, along with a rate cut, spooking foreign investors and pressuring the peg, which does not have a similar weak side undertaking.
Meanwhile Governor Coomarasway said Friday one reason rates were not cut this month was due to currency instability.
“…[F]rom time to time, in recent week, there has been some pressure on the rupee,” he said
“It has stabilized in the last few days. Yesterday again, there was a little bit of pressure.
“So at a time when there is some pressure on the rupee – clearly if it depreciates then that also could put pressure on prices. And that’s another reason for holding the rate.”
Analysts have pointed out that it is not so easy to generate currency trouble by injecting liquidity when private credit is weak or negative, but budget deficits are deteriorating.
Private credit also generally picks up about a year after the previous currency crises ends.
Sri Lanka’s rupee started to come under pressure shortly after the money printing central bank was set up in 1950. Draconian trade and exchange controls followed.
There have been calls to abolish the central bank or force it to either operate a consistent peg or genuine inflation targeting with a floating rate to avoid balance of payments trouble and continued monetary instability. (Colombo/Oct11/2019)