ECONOMYNEXT – Sri Lanka has lifted yield controls on next week’s 12-months Treasury bills auction abolishing a 12-month de facto policy rate through which large volumes of liquidity was injected, leading to forex shortages and reserves losses.
Newly appointed Central Bank Governor Nivard Cabraal had said he was placing stability ahead of growth.
“There are no shortcuts,” he said in his first speech at the central bank. “Sometimes there are tough policy measures to be taken.
“When we take policy measures there are always repercussions from another side. Sometimes if you do not take those policy measures you meander along.”
“When a tool is used, and one area is getting cured, it can emerge as a problem in another area,”
“It is not easy to manage this balance. You have to be conscious of all the outcomes that generally arise when you take certain policy measures.”
Sri Lanka’s economy is operating under difficult conditions like many other economies, but vaccination is going at an accelerated pace helped by China’s Sinopharm, but interest rate controls and an earlier tax cut had triggered forex reserve losses from liquidity injections.
The debt office which is a unit of the central bank is offering 39.5 billion rupees of bills at the auction on 22 September 2021.
No mention was made of the yield controls. The yield controls started in the second quarter of 2020 from early April 2020.
The debt office is offering 10 billion rupees of 3-month bills, 13 billion rupees of 6-month bills and 16.5 billion rupees of 12-month bills.
Investors had been bidding only for 3-month bills over several months, leading to large volumes of new money being injected, which analysts said was leading the country towards dollar sovereign default.
Last week, the debt office also increased ceiling rates of a bond action, without lifting them all together, and there was surprisingly strong demand for a 2031 bond at around 10 percent.
“There may be some spikes in rates as bidders try to find a level,” one dealer said. “But they will settle after some time.”
A bond maturing on 01.12.2024 closed at 8.00/20 percent after the price controls were lifted, slightly higher from an earlier level of around 7.98 percent.
A 01.02.2025 bond closed at 8.90/90 percent up from 8.75/90 percent.
Sri Lanka had unrealistically low-interest rates amid a budget deficit of over 10 percent of GDP, which led to a number of anomalies in the forex markets and steady foreign reserve losses.
In late August the central bank hiked policy rates by 50 basis points to 6.0 percent, but failed to remove the price ceiling, leading to more liquidity being injected.
A statutory reserve ratio rate of 2.0 percent was also hiked to 4.0 percent creating a big liquidity short, which was fully sterilized with new liquidity at 6.0 percent.
It was not clear why the SRR was raised and overnight rates hiked, before removing the de factor rates further along the yield curve.
Meanwhile Sri Lanka’s forex markets are still dysfunctional with a non-credible peg decreed at 203 to the US dollar with no convertible undertaking deployed and unlimited amount of liquidity injected overnight at 6.0 percent to sterilize liquidity shorts. (Colombo/Sept15/2021 – correction yield control 2020 2Q not 2021 as mentioned in an earlier version of this story)