ECONOMYNEXT – A key domestic asset stock of Sri Lanka’ central bank went up by over 8 billion rupees to 291 billion rupees on April 24 on the settlement day for a Treasuries action data showed as the sovereign rating was downgrade to a notch above CCC.
Midweek there were fears that around 08 billion rupees or more in new money would be printed to buy Treasury bills in to the central bank balance sheet to target 03, 06, and 12 month bill yields which were kept rock steady from a week earlier by under-selling offered volumes.
At Wednesday’s auction 22 billion rupees of bills were sold for existing money after offering 30 million rupees in bills.
On Friday, the settlement day of the auction, the central bank’s Treasury bill stock went up to 291 billion rupees from 283.9 billion rupees a day earlier.
Excess liquidity in money markets rose to 142 billion rupees on Friday from 131 billion rupees a day earlier.
The money was printed while overnight markets were flushed with 132 billions of money injected by Thursday April 23, through ‘helicopter drop’ style moves, a statutory reserve ratio cut and a central bank profit transfer.
The Treasuries stock of the central bank rose from 69 billion rupees on January 30, to 291 billion rupees by April 2024.
Under ex-Governor Indrajith Coomaraswamy, the central bank was also given authority to buy longer term bonds, a practice stopped by then-Governor A S Jaywardene, a classical economist, to stop the central bank from distorting rates further down the yield curve.
Sri Lanka is also targeting a call money rate in the middle of the policy corridor with excess liquidity injections which lost the rupee protection of a policy corridor. Under Governor Coomaraswamy the policy corridor was also narrowed to 100 basis points from 150.
Analysts had already forecast that rates would be cut in 2020 to trigger a balance of payments crisis and downgrades, most likely with a rate cut and liquidity injections later in the year as the economy recovered from 2018 currency crisis.
Monetary instability in 2020 began with a rate cut on January 30 ahead of expectations and the rupee came under pressure earlier, with Coronavirus adding fuel to the fire.
However rate cuts and liquidity injections had triggered currency collapses earlier without any help from external instability.
The liquidity injections came on top of tax cuts made in January.
On Friday Fitch Ratings cut Sri Lanka’s sovereign rating from ‘B’ to ‘B-‘.
“The shock to Sri Lanka’s economy from the coronavirus pandemic will exacerbate already-rising public and external debt sustainability challenges following tax cuts and an associated shift in fiscal policy late last year,” Fitch Ratings said.
“Sri Lanka’s external financing challenges have increased in the current environment of global risk aversion and financial market volatility, with large upcoming external debt redemptions and limited foreign-currency (FX) reserves.”
All previous downgrades had also been associated with domestic asset purchases (net credit to government). In 2018 money was printed to target call money rates and trigger monetary instability with full central bank independence, a falling deficit and market pricing of oil.
Analysts had warned Sri Lanka not to print money in 2020 as the country did not have enough rating space to take monetary risks, with Sri Lanka’s ‘B’ rating only two notches about CCC.
“Sri Lanka will face credit downgrades and possible sovereign default of dollar debt unless the highly unstable discretionary ‘flexible exchange rate’ is restrained and some monetary discipline is brought in,” EN’s economic columnist warned last year.
“The next downgrade will take Sri Lanka to B-. Sri Lanka is a country that had mostly kept monetary stability in the worst years of the war with the help of the ideology then prevailing.
“But now each new episode of monetary indiscipline is costing the country one notch in the rating scale.
“Sri Lanka will soon run out of rating space to tap capital markets if the flexible exchange rate/call money rate targeting continues in the next recovery space.”
Now Sri Lanka’s rating is only one notch above CCC.
(Colombo/Apr25/2020 – Update II)