ECONOMYNEXT – Sri Lanka has failed to sell 74 percent of a 45 billion rupee ‘auction’ of Treasury bills conducted under price controls, official data shows as a balance of payments deficit continues and the monetary authorities bill stock topped 824 billion rupees.

The debt office managed to sell more 3-month bills with the one year yield curve continuing to flatten towards to 5.11 percent ceiling placed on 12-month yields.

In 3-month bills 9.0 billion rupees were sold at 5.04 percent, up 03 basis points, after offering 10.0 billion rupees.

In 6-month bills 1.1 billion rupees were sold at 5.08 percent, up 01 basis point after offering 15 billion rupees.

In 12-month bills 1.3 billion rupees were sold at 5.11 percent, the price-controlled yield, after offering 20 billion rupees.

The central bank has been purchasing large volumes of bills by printing money to keep rates down expand reserve money and trigger a balance of payments troubles for over a year under so-called ‘Modern Monetary Theory’.

It is not clear whether the central bank already holds a part of the 45 billion rupees in bills offered.

In the week to March 24, the central bank’s Treasury bill stock rose to 824 billion rupees from 810 as a bill ‘auction’ failed to fully sell the offer amid price controls.

A further 37 billion rupees were borrowed by banks which were short of rupee reserves from its overnight window. Any outright purchase of bills from this auction would ‘validate’ the borrowing into non-borrowed reserves.

The rupee is now at over 200 to the US dollar from around 182 at the beginning of 2020.

In 2020 Sri Lanka ran a balance of payments deficit of 2.3 billion dollars.

Sri Lanka is now under the worst import controls since the 1970s and prices of banned items are soaring giving large profits (rents) to import substitution business also known as the cronies or Mercantilists.

In Sri Lanka there is a strong mercantilist belief that monetary instability in the form of currency falls and BOP deficits are caused by trade rather than monetary policy.

There is also no knowledge that the domestic solvency is required to maintain external solvency.

In 1975 a classical economist had warned against the practice of printing money to buy Treasury bills explaining the link between failed bill sales, the balance of payments and rupee.

In 2021 there is demand for bills, but they are not sold under the price control which has been set at 5.11 percent for this week’s auction.

“The Treasury had to finance its expenditures increasingly by resort to Treasury bills despite the fact that no significant tenders forthcoming to absorb the successive issues of Treasury bills,” an unknown classical economist wrote in 1975 in the central banks’ 25 anniversary publication.

“The responsibility of absorbing the unsubscribed portion of the Treasury bill issue fell on the central bank.

“A major drawback in financing of budget deficits with central bank credit is that while the process involves an expansion in the money supply, it is not necessarily accompanied by an expansion by a corresponding increase in national product.

“Consequently, increased demand emanating from central bank financing of budget deficits had to be satisfied by increased recourse to foreign supplies with resulting pressure on the country’s external payments.

“Thus, though the Government fiscal problem and the balance of payments deficits were two distinct problems, they were nevertheless inter-related, in that the balance of payments deficits and loss of external assets arose partly out of the method by which the government sought to finance its deficits.

“With the continued loss of reserves and the accumulation of external liabilities, the ability of the Central Bank to maintain the international value of the rupee was gradually undermined. ”

In January 2021, the BOP deficit was 690 million US dollars. Sri Lanka’s external drain in 2020 and 2021 is mostly caused by debt repayments after confidence was dented by previous money printing which led to currency collapses and growth shocks.

The current BOP deficit dates back to around August 2019, when money was printed despite running a pegged exchange rate to target an output gap.

Sri Lanka’s central bank constitution however has no growth mandate, only a mandate for price and economic stability. (Colombo/Mar25/2021)