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Sri Lanka excess liquidity drops to Rs100bn amid reserve outflow, CB bill stock Rs824bn

ECONOMYNEXT – Net excess liquidity in Sri Lanka’s money markets dropped to 100 billion rupees on March 23, levels not seen since June 2020, while overnight borrowings from the central bank rose to 32 billion rupees.

On March 23, banks deposited excess liquidity of 132 billion rupees in the excess cash window of the central bank at 4.50 percent.

Some banks which were short of cash borrowed 32 billion rupees from the 5.5 percent window, the highest since June 01, 2020.

Excess liquidity in Sri Lanka’s money market rose from around the 10 to 15 billion rupees seen during periods of monetary stability to over 200 billion rupees in 2020 as large volumes of money was printed under Modern Monetary Theory, triggering currency weakness, reserve losses and credit downgrades.

Excess liquidity deposited in the window are at levels seen in 2015, when a soft-pegged currency crisis was triggered with large liquidity released based on the claim that inflation was too low.

In both cases large volumes of excess liquidity was injected to keep rates at the bottom of the policy corridor.

The 2018 crisis analysts have shown, was triggered by large volumes of excess liquidity injected to keep call rate in the middle of the corridor.

When foreign reserves run out, a soft-pegged central bank will usually put corrective measures involving, sudden rate rises, liquidity shortages and a float.

After 2015 floats have been attempted in Sri Lanka with large volumes of excess liquidity remaining, leading steep falls in the currency.

Since 2015 when ‘flexible’ policies with shifting rules began the rupee has fallen from 131 to 200 to the US dollar.

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In the week to March 19, the Treasury bill stock of the central bank rose to 824 billion rupees from 810 billion as the monetary authority printed money to buy Treasury that failed to be sold to the public under ceiling yields.

Sri Lanka had printed 754 billion rupees since February 2020. In the period gross foreign reserves had fallen by 3.39 billion US dollars as the newly minted money flowed out in what classical economists call an ‘external drain’.

An ‘internal drain’ involving higher notes in circulation in 2020 amid a Coronavirus pandemic was also accommodated by reserve ratio cuts separately.

Since then inflation has also expanded reserve money, defined without overnight excess liquidity. In January 2020 reserve money was around 930 billion rupees.

By March 2021, reserve money had topped a trillion rupees, overtaking SRR cuts. SRR cuts makes the banking sector more efficient and can bring down spreads.

In Sri Lanka foreign banks and the top private banks which are well managed are usually plus cash (have excess reserves) and do not put pressure on the rupee.

State banks, which finance the government and subsidies of energy utilities put tend to be short of cash and puts pressure on the currency through window borrowings, analysts have said.

The 100 billion rupees of excess liquidity remaining in March amounts to around 500 million US dollars of potential foreign reserve losses at an exchange rate of 200 to the US dollar.

Most of the reserves in the current crises went through the financial account as debt repayments amid weak private credit in contrast to previous currency crises when strong credit growth partly driven by fuel subsidies financed with printed money de-stabilized the peg through mainly commercial transactions.

Sri Lanka’s current balance of payments troubles started around August 2019 when money was injected to target an output gap by controlling overnight and longer term yields.

The central bank however has no growth mandate. (Colombo/Mar24/2021)

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