Sri Lanka injects more rupees amid currency pressure
ECONOMYNEXT – Sri Lanka has injected 10.5 billion rupees of newly minted money for two weeks at a weighted average yield of 8.00 percent through a term reverse repo auction, 50 basis points below the ceiling policy rate despite currency pressure.
On September 11 the central bank injected 9.2 billion rupees at 8.09 percent for two weeks ending September 26 through a term reverse repo auction.
On September 12 another 12.5 billion rupees were injected for two weeks ending September 27.
The rupee hit 162.85/163.00 to the US dollar on Monday.
Printed money from the central bank allows banks to give credit without raising deposits from the real economy, generating an excess of dollar outflows over inflows.
The printed money can also be used to buy bonds from exiting foreign investors at lower rates than if new money was not available, giving them more profits and liquidity to exit. Due to the newly minted money, a bank does not have to stop domestic credit to buy a bond, but can do both.
However injecting money for two weeks puts some pressure on banks to raise deposits than purchasing Treasury bills outright and permanently injecting cash in to the credit system to generate a permanent ‘balance of payments deficit’ in the ensueing weeks.
Analysts who closely track the central bank has said that in times of currency pressure, cash should only be injected overnight at the highest ceiling rate, so that banks are under pressure to raise deposits every day at 8.5 percent and a balance of payments crisis does not develop.
Sri Lanka’s rupee is now under the second period of pressure in 2018. The latest episode was triggered after the central bank injected money from a currency swap in the style of an unsterilized dollar purchase made in a pegged exchange rate regime.
Only about 10 billion rupees of the new money was sterilized by a sell-down of its Treasury bill stock.
After keeping cash unsterilized, the central bank failed to defend the currency against the new liquidity through unsterilized dollars sales to maintain the pegged regime, and instead allowed the new liquidity to depreciate the currency as if it was a floating rate.
Earlier in the month, the central bank also cut net open dollar positions of banks, sharply narrowing the depth of the foreign exchange market, generating more volatility unless the central bank intervenes even more.
EN’s economic columnist explained in June (long before NOP limits were cut) that the focus on overnight dollar positions was based on a mistaken doctrine.
"These Net Open Position Limits have limited value," Bellwether pointed out. "The entire focus on dollar holdings is misplaced.
EN’s economic columnist explained in June that in foreign investors who speculate against currencies including George Soros, the-man-who-failed-to-break-the-Hong-Kong-currency-board, usually raise cash from swaps with commercial banks which are then re-financed from the central bank through the overnight cash window.
"Just because George Soros, or any other investor, had billions of dollars, he cannot hit Sri Lanka’s rupee dollar exchange rate," Bellwether explained in a June 2018 column.
"To hit the exchange rate, he has to get hold of some rupees first. Usually, a speculator will try to get ahold of some domestic currency by doing a currency swap. If there is only a limited amount of rupees available, the swap rate will hit the roof.
"When a foreign speculator tries to hit a currency, they succeed because money comes from the discount window to do so and the rate does not go up too much."
"This is why George Soros had to run from Hong Kong with his tail between his legs, as swap rates went up, while bigger countries collapsed. There is no true discount window at a currency board."
In Sri Lanka latest currency panic, the central bank directly created the money by becoming a counterparty to the swap.
The excess liquidity from swaps has since disappeared but the credibility of the peg has been broken again.
A May/June episode of currency pressure was generated by the central bank purchasing Treasury bills outright and engaging in a so-called ‘buffer strategy’ involving repaying bonds with a state bank overdraft which is then re-financed with window money, analysts have said.
Bellwether had proposed a series of measure to strengthen the currency and prevent panics from pushing up interest rates in the June column (What Sri Lanka can do to improve the credibility of its dollar soft-peg: Bellwether) (Colombo/Sept14/2018)