ECONOMYNEXT – Sri Lanka’s central bank printed 2 billion rupees at for 315 days at 7.94 percent, and 264 million rupees at 7.90 percent, through outright purchases of bills, below the 8.0 percent policy rate for overnight liquidity injections, official data shows.
The rate setting monetary board cut the cash injection rate to 8.0 percent from 8.5 percent last week, despite the rupee coming under pressure from large scale money printing that began from August 07.
The domestic operations departments printed 20 billion rupees at 7.83 percent from August 07, and banks with excess cash deposited 50 billion rupees in the excess cash window, reversing earlier prudent policy, that kept the exchange rate stable.
Until July 17, the central bank has been withdrawing excess cash at around 7.70 percent keeping overnight rate above market and also above the minimum 7.50 percent set by the monetary board.
There were two rates cuts which were enforced without printing money, and no threat to the rupee, no threat to an International Monetary Fund foreign reserve target.
Amid monetary stability, market rates were gradually falling.
The central bank stopped regularly draining liquidity on July 17, and allowed excess liquidity to build up from dollar purchases made to enforce a pegged exchange rate (a balance of payments surplus) until August 07.
Money printing began from August 7, 20 to 25 billion rupees overnight and for longer terms, pushing down rates across the yield curve.
On August 16, a sudden large bill sell down was made. It is not clear why such a large sell-down was made or why large volumes of money was injected below the policy rate earlier, worsening pressure on the rupee.
Instead of mopping up the excess liquidity when pressure came on the rupee and allowing rates to rise, the central bank then allowed the rupee to slid with more money printed to push up liquidity back to where banks deposited 30 billion rupees in the excess window.
The policy reversal on August 07 seems to have come from targeting a call money rate, according to official statements made later.
The money printed on August 29, allowed some banks to deposit 7.48 billion rupees at the excess window, while other borrowed 9.45 billion rupees from the 8.00 percent overnight policy window.
Critics have said that in 2018, the central bank generated monetary instability with periods of extended unsterilized liquidity and money printing both in February April and July – September, just as the economy was recovering.
“The principle source of the current instability seems to have come from targeting a call money rate with printed money and other rates along the yield curve below the ceiling policy rate,” EN’s economics columnist Bellwether says.
“As a result Sri Lanka lost the insurance of its Standing Lending Rate or the ceiling policy rate.
“Whenever money is injected for extended periods, the balance of payments will turn into a deficit, the central bank will miss its IMF reserve targets and the government will not be able to generate dollars to repay debt, leading to potential defaults of its dollar debt, Weimar Republic style.”
“While it is easier to contain periods of monetary instability and is more difficult to trigger new ones when private credit is weak or negative, there are many examples – Argentina is a prime example – where the central banks generate instability despite contracting economic output.” (Colombo/Aug30/2019- Update II)