Sri Lanka liquidity short expands in Nov final week

ECONOMYNEXT – A liquidity short in Sri Lanka’s credit system coming mainly from interventions in the forex market by the central bank had expanded over the past week, after falling due to a reserve ratio cut, amid a political crisis and capital flight.

The central bank had sterilized a short of about 135.9 billion rupees (about 750 million US dollars) by November 30, up from 109.0 billion rupees (about 600 million US dollars) a week earlier mostly through temporary liquidity injections, official data showed.

Sri Lanka’s reserve money fell for two weeks in a row after a statutory reserve ratio (SRR) cut on November 16, permanently sterilizing a liquidity short, central bank data showed.

The liquidity short fell from 174.2 billion rupees to 108.2 billion rupees in the week to November 16.

Reserve money fell from 1,021 billion rupees on November 15 before the SRR cut to 958 billion rupees on November 21.

By November 29, reserve money had fallen by another 20 billion rupees to 938.1 billion rupees, but the liquidity short had started to move up.

Reserve money is the narrowest form of money created by domestic liabilities of the central bank, through which final transactions in the economy are cleared.

When the SRR it cut, part of the money deposited in the central bank by commercial bank comes back into circulation and a bank that is short can use the cash to reduce the liquidity short, while another bank, can use the cash to give fresh credit or buy bonds from foreigners, worsening pressure on the rupee.

Reserve money can also change from day to day due to the demand for additional cash from the public.

In December and in April festival season cash demand goes up expanding reserve money.

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Analysts have pointed out that the central bank triggered pressure on the currency in April, by printing more money than required and keeping markets flushed with excess liquidity to enforce a rate cut.

In December there are also higher volumes of remittances and exporter dollar conversions to pay salaries and bonuses.

The ongoing political crisis may have also slowed private credit and government spending, though it is not clear whether it is enough to absorb capital flight.

Economists and analysts have called for reforms of the central bank to put the brakes on its domestic operations department to stop printing money, or abolish the agency altogether in favour of a currency board or dollarization to end balance of payments crises in Sri Lanka.

Sri Lanka started having balance of payments trouble after a central bank was set up in 1951, abolishing a currency board which kept the country stable two through World Wars and provided a hard budget constraint to stop deficit spending. (Colombo/Dec03/2018)

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