Sri Lanka intervenes to defend rupee after liquidity injections

ECONOMYNEXT  – Sri Lanka has intervened in the forex markets to defend the rupee, Central Bank Governor Indrajit Coomaraswamy said after a 50 basis point policy floor rate cut to 7.00 percent.

"We have intervened in the market in the last few days," Governor Coomraswamy said in Colombo on August 23.

"Last three days, we think the pressure there is not aligned with the underlying fundamentals."

"In recent days we have seen pressure in the FX market but the underlying fundamentals do not explain this pressure so that may be short-lived.

He said there may be other ‘non-economic’ factors disturbing the market.

Governor Coomaraswamy said there were about the equivalent of 700 million US dollars of rupee bonds in the hands of foreign investors some of whom have begun to sell.

"Even if all of that goes out, which it won’t, we can handle it," he said.

Sri Lanka had about 8.2 billion dollars of forex reserves and as a rule of thumb authorities were comfortable with 6.5 billion US dollars, he said.

Governor Coomaraswamy said under ‘flexible inflation targeting" Sri Lanka would avoid intervening in the forex market and would seek to correct ‘disorderly’ adjustment, that was not in line with underlying fundamentals.

Sri Lanka was injecting printed money into the banking through several overnight and term lender of last resort facilities near the previous policy deposit rate in the run up to a rate cut on August 23, to fill a liquidity shortage unrelated to the balance of payments.

The central bank also injected additional cash not just to fill the liquidity contraction, but also to generate excess liquidity.

But some injections were made before the liquidity contraction. Beforre August all excess liquidity came from pegging – buying dollars to prevent an appreciation.

Analysts have called for ‘floating with excess liquidity’ to be made a criminal offense to reduce monetary instability.

Sri Lanka’s private bank credit has weakened up to June, reducing activity and imports. (Colombo/Aug23/2019)