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Sri Lanka excess liquidity soars to Rs223bn amid rupee fears

ECONOMYNEXT – Sri Lanka’s excess liquidity in money markets soared to a historic high of 223 billion rupees after the statutory reserve ratio was halved in the wake of President Gotabaya Rajapaksa slamming the central bank over a re-finance fund, raising fears for the currency.

The central bank halved the Statutory Reserve Ratio or the share of deposits commercial banks must keep with the central bank from 4 to 2.0 percent releasing over 100 billion rupees into the banking system, which already had 90 billion rupees of excess liquidity a day earlier.

In addition to slashing the SRR the central bank said it will also re-finance (print new money) up to 150 billion rupees to fund loans by the banking sector in a late-night announcement.

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“Panicked by tongue-lash of @GotabayaR, @CBSL has unloaded Rs112 bn by cutting SRR to 2% on banks already with excess liquidity of Rs100 bn+a refinance facility of Rs150 bn misreading the issue as lack of liquidity,” former Deputy Governor of the Central Bank W A Wijewardene said in a twitter.com message.

“It will have repercussions on other sectors such as depositors getting less, T bill and bond rates down, expected foreign flows to that market dwindling & rupee under further pressure for depreciation; shouldn’t resort to policies under panic..”

President Gotabaya Rajapaksa summoned Central Bank Governor W D Lakshman and senior staff to his office and berated them for not agreeing to create 100 billion rupees in new money for banks to fund loans, tripling an existing 50 billion rupee program.

Sri Lanka’s bond yields plunged 50 basis points on June 17.

Sri Lanka’s rupee fell to around 195 to 200 to the US dollar in spot and one week markets after earlier liquidity injections drove credit up in March and importers covered early.

The exchange rate weakens when liquidity injections turn into imports through the credit system or state spending on salaries, and the central bank fails to supply enough dollars to ‘mop up’ or redeem the new rupees that end up in forex markets.

April data showed private credit hardly grew.

In May the rupee gained back to around 185 to the US dollar and the central bank bought US dollars in forex markets to stop further appreciation.

Sri Lanka has imposed severe import controls after the rupee fell.

Wijewardene said the reluctance of banks to give credit as envisaged was not related to liquidity but due to fear of default, which had to be addressed by a credit guarantee.

Without a credit guarantee, banks are risking capital and therefore deposits.

The excess liquidity is over 20 percent of pre-SRR cut monetary bases. It would be about 25 percent of the monetary base (without excess liquidity) after the SRR cut.

Wijewardene warned that sterilization costs of the central bank would rise. The central bank will pay banks at the standing deposit facility rate of 5.5 percent at least until the rupees disappeared in lost foreign reserves spent to mop them up in which case dollar interest on foreign reserves would fall.

Banks deposited 223 billion rupees in the excess on Wednesday. SRR cuts boost rupee reserves of banks allowing them to earn more profits and lend more or buy bonds.

Hours before the SRR cut, President Rajapaksa said the central bank had not responded to this order to increase a loan scheme financed with re-finance of to 150 billion rupees.

President Rajapaksa had said the central bank had to give him an answer within a day.

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