Sri Lanka money market liquidity soars, some foreign selling in bonds

ECONOMYNEXT – Excess liquidity in Sri Lanka’s money markets soared to 76.6 billion rupees on May 03, as cash injected for a April holiday drawdown returned to banks, while data also showed foreign selling in bonds.

The rupee was quoted 177.30/50 to the US dollar on the spot-next market (spot plus one day) on Monday, dealers said, around the same levels as Friday. The rupee has weakened since the attacks.

Foreign investors sold down their stock of rupee gilts to to 154.5 billion rupees in the week to April 30 from 157.5 billion a week earlier.

Sri Lanka’s Central Bank usually injects cash into money markets in April, as reserve money expands to accommodate an expansion in real demand for cash.

The money comes back into the banking system from the last week of April, which leads to pressure on a rupee peg in May, unless the cash is mopped up quickly, especially when the private credit is strong.

Sri Lanka’s private credit has been weak in January and February, slowing economic activity and dollar outflows, allowing the Central Bank to buy dollars from commercial banks expanding dollar-backed reserve money to operate its peg with the US dollar.

The Central Bank is also believed to have bought fiscal dollars, expanding dollar-backed reserve money in the course of operating a peg with the US dollar. This money can be redeemed by selling the dollars.

The Central Bank has also injected 32 billion rupees of cash through term reverse repo deals (injecting money against Treasury bills) in the course of operating a soft peg, for which there is no foreign reserve backing.

The Central Bank depreciates the rupee by two main methods: injecting cash through reverse repo or term reverse repo deals (lender of last resort operations), buying Treasury bills outright, defending the currency and then printing more money to offset the defence.

It can also push the rupee down by after buying dollars, generating unsterilized liquidity, but not defending the peg when the dollar liquidity comes up for redemption in forex markets either through credit driven imports or bond sales.

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Analysts have said in case the soft-peg comes under pressure, liquidity should be extinguished and the currency floated.

On May 08, 10 billion rupees of term reverse repo deals are due to expire, another 12 billion rupees will expire on May 09 and another on May 10.

Sri Lanka operates the most unstable monetary regime known so far, of printing money to maintain a policy rate and then running a peg to collect forex reserve or to target a real effective exchange rate.

A country that targets are REER, will depreciate the currency, push the prices of traded goods up, destroy real wages and capital, even where there is a balance of payments surplus. (Colombo/May06/2019-SB)

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