Sri Lanka central bank scrambles to contain damage from printed money
ECONOMYNEXT – Sri Lanka’s central bank has scrambled to undo the damage to the rupee and the economy after the Treasury repaid around tens of billions of a maturing bond on January 02 with printed money.
Excess liquidity in the banking system which was 39 billion rupees on December 30, shot up to 108 billion rupees on January 02, after the Treasury repaid a maturing bond with printed money.
The Treasury bill portfolio of the central bank shot up from 236 billion rupees on December 29 to 331 billion on January 02.
The Treasury prints money by forcing the Central Bank to buy securities with printed money. It can also ask the Central Bank to give a ‘provisional advance’.
The printed money is then spent by those who receives them (old bond holders or state workers if they are used to pay salaries), and the newly created money then ends up in forex market via imports.
Unless the cash is quickly taken back (sterilized) by selling down Treasury bills (with rates rising), foreign reserves will have to be spent to mop up the rupee and defend the exchange rate.
The central bank sold down 5.5 billion rupees of Treasury bills in its portfolio through three outright auctions over January.
It did not roll-over maturing bills in its portfolio, and the bills were sold to the public at weekly auctions, mopping up the newly printed money, allowing rates to go up in the process.
The central bank usually triggers balance of payments crises by rejecting real bids and printing money to taking bills into its portfolio to keep rates down.
The one year Treasury bill rate went up to 9.03 percent from 8.72 percent in the last week of December. The six month yield went up to 10.07 percent from 9.63 percent and the 12-month yield went up to 10.37 from 10.17 percent in the process.
The Treasury would have been able to achieve the same effect if bills were sold (short term debt) to raise cash and repay bonds (long term debt) but without any de-stabilizing effect on the rupee or on inflation.
Printing money and injecting rupees into the banking system, allows banks to give more loans in excess of the deposits they raise, pushing up demand and inflation.
If imports are made to fill the demand, foreign reserves would be lost as the rupee is defended. If the currency is not defended, the rupee will fall pushing prices of imports and exports.
By Friday January 27, its Treasury bill stock was down to 250.6 billion rupees (book value) and excess liquidity was down to 41 billion rupees. On Friday 46 billion rupees of excess cash was mopped up through an overnight repo auction.
Sri Lanka does not have a free floating currency, but intervenes in forex markets and is also under an International Monetary Fund target to rebuild forex reserves. As a result any acquisition of domestic assets will weaken the rupee or generate a reserve loss or both.
Analysts have pointed out that a lack of a periodically falling domestic asset ceiling on the Central Bank as a performance criteria, will undermine any forex reserve targets, and may lead the program unraveling.
Such a performance criteria would also have protected the central bank, the IMF program and the country from events such repaying debt with printed money. (Colombo/Jan30/2017)