ECONOMYNEXT – Sri Lanka has printed tens of billions of rupees, in one of the largest volumes of central bank credit extended in a single day in the history of the central bank to finance cash-strapped public finances, official data show.
The move helped flood the banking system in 108 billion rupees of excess liquidity, undermining monetary policy aimed at keeping inflation low and putting further pressure on the rupee analyst say.
The central bank’s Treasury bill stock, rose from 219 billion rupees on December 29, 2016 to 330 billion rupees on December 30, indicating a 110 billion rupee increase in the main proxy for central bank credit.
On January 02, Sri Lanka had to roll-over an estimated 119 billion rupees of bonds and interest coupons. This included 72 billion rupees of a bond maturing on 01.01.2017 and the balance included interest payments falling due from other maturities.
But the government only called bids for 57 billion rupees of bonds accepted bids for of 55 billion rupees, leaving a balance of about 64 billion rupees to be financed through other means.
Bond dealers were told before the auction that the Treasury had enough cash to repay the bond and the balance will not be offered for auction.
Initially analysts who study the central bank closely assumed that the sudden rise in Treasury bill stock on December 30 may have been due to a forex reserve appropriation to repay foreign debt, as excess liquidity did not move up in tandem.
But on January 02, net excess liquidity in the banking system shot up by 68 billion rupees to 108 billion rupees, from 39 billion rupees on December 30, indicating that a massive volume of money had been printed and let loose, flooding the banking system.
Some banks which had borrowed 30 billion rupees on December 30, only borrowed 8.6 billion rupees on January 02, trimming an existing liquidity shortage.
When bonds are repaid with printed money, avoiding sovereign default, banks will lend the newly created money to their customers, instead of raising deposits. The newly minted money will create import demand exceeding the total dollar inflows to the country, putting pressure on the currency.
Meanwhile transactions that are cleared and made possible with the new money can push up future inflation.
Until the cash is mopped up by selling down the Central Bank’s Treasury bill stock again, the central bank will lose foreign forex reserves as the printed money hits forex markets in the form of imports via the credit system.
Meanwhile, the central bank has begun to sell Treasury bills outright to mop up the liquidity.
Long-time central bank watchers say outright sales of Treasury bills to mop up the newly created liquidity shows that the central bank is acting to prevent further damaged to the economy. It also indicates that the money may have been printed at the behest of fiscal authorities, indicating a severe case of fiscal dominance of monetary policy, they say.
Analysing liquidity and domestic assets of the central bank in early January is further complicated by the existence of so-called provisional advances, which is printed money given to the Treasury with no interest, putting pressure on the rupee and creating inflationary pressure, unless mopped up.
Due to a flaw in the constitution of the Central Bank which has not been corrected, the Treasury can to force the monetary authority to print money via provisional advances, up to 10 percent of the revenue listed in the budget of a given year.
By end 2015 the central bank had extended 155 billion rupees of printed money for the budget. In 2016 Sri Lanka expected about 1.6 trillion rupees of revenue. The 2017 target is about 2.0 trillion according to data given to parliament.
Updated data on provisional advances are not published regularly.
There has been rising concerns over recently fiscal dominance of monetary policy and at perceived attempts to undermine the independence of the central bank.
Analysts warned in 2015, that the lack of a tapering ceiling of domestic assets (net claims on government) of the central bank would endanger the forex reserve targets and lead to further depreciation of the rupee.
A ceiling on claims on government would also have protected the central bank and the poor, against fiscal dominance. (Colombo/January 06/2016).