Sri Lanka converts Treasury overdrafts with state banks to bonds

ECONOMYNEXT – Sri Lanka has cut Treasury overdrafts from state-banks by a lump sum administrative issue of at least 248 billion rupees of government bonds, official data show.

The outstanding Treasury bond stock went up to 5,719 billion rupees on December 30, from 5,470.7 billion rupees a week earlier, as the new bonds were issued outside the auction process.

The finance ministry’s overdrafts with the two state banks had soared to 541 billion rupees by August 2020, from 219 billion in January.

The administrative bonds would allow the Treasury to start 2021 with a lower overdraft.

It was a common practice before 2015, which may or may not involve financial repression, but does not generate monetary instability, or bring the country closer to sovereign default, analysts say.

The conversion of overdrafts to Treasury bonds is a book transaction that does not involve printing money, expanding the monetary base, which then drives credit, de-stabilizing the credit system, triggering forex shortages, currency pressure and foreign reserve losses.

Unlike rejecting bids at bill auctions and refusing to roll-over maturing bills which turn paper securities into new rupees which can be converted to dollars, triggering monetary instability, the conversion of an overdraft to a Treasury bond has no effect on reserve money.

Analysts have pointed out that around April 2018, the debt office did not roll-over all maturing bonds, but repaid a part with a bank overdraft – which in turn can be re-finance with printed money from lender of last resort windows- expanding reserve money and triggering a fall the currency.

It was called the ‘buffer strategy’. In 2020 tens of billions of rupees were directly printed to reject real bids and Treasury bill auctions, keeping rates low, triggering import controls, more revenue losses, which in turn triggers more money printing, and large losses of foreign reserve losses through the financial account.

Forward dollar rates have also inverted as a result with domestic dollar yields spiking above rupee rates. (Colombo/Jan10/2021)

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