ECONOMYNEXT – Sri Lanka has monetized 50 billion rupees of debt taking on excess liquidity in money markets 235 billion rupees in the first week of December 2020, from 185 billion rupees, official data shows.
The central bank’s Treasury bill stock went up to 618 billion rupees on December 01 from 568 billion rupees at the end of November.
While stock prices have picked up distortions are also beginning to be seen in forex swaps and forwards, markets participants say.
Sri Lanka’s rupee fell steeply in March 2020 to close to 200 to the US dollar from around 181, amid a surge in credit under a so-called ‘flexible exchange rate’ where peg defence is delayed after money printing until the market gets unsettled, critics have said.
The central bank intervened at levels around 200 to the US dollars and the country’s unstable soft-peg was kept around 185 to the US dollar as credit collapsed from April onwards, with lockdowns reducing consumption, allowing the central bank to buy dollars.
Central Bank Governor W D Lakshman had said under Modern Monetary Theory, money to be printed within a sovereign area to repay debt.
In the first week of December, bills were undersold at a Treasury bill auction on top of the 50 billion rupee injection earlier in the week.
Private credit has been positive for the last three months.
The spot rupee has not been quoted actively in forex markets in recent days.
The spot next (spot+ one day) was quoted around 186.50/70 to the US dollar on Thursday. A state bank was seen selling dollars around 186.60 levels, dealers said.
With excess liquidity at 235 billion rupees the potential pressure on the rupee is about 1.2 billion dollars if domestic credit continues to pick up, analysts say. It is unclear whether the surge in Coronavirus in October will contribute to a weakening of credit.
Though import controls are in place, credit is fungible and authorities are pushing credit. On top of money printing, which includes re-financed credit, a directed credit program is planned and price ceilings are to be placed on housing loans at 7 per cent.
After the March ‘flexible exchange rate’ episode, a process under which money is printed but the peg is not defended when the liquidity turns into imports via the credit system, Sri Lanka’s credit was downgraded to B- and then CCC.
The currency fall pushed up yields of Sri Lanka’s sovereign bonds to 20 to 30 per cent levels and made it impossible to roll them over.
Several banks had also bought Sri Lanka sovereign bonds at steep discounts.
Meanwhile, banks are also finding it difficult to roll over maturing off-shore borrowings after the credit was downgraded to CCC which is also making dollar liquidity tight, market participants said.
Coupled with the low rupee rates from money printing, this had made swap premiums plunge with quotes going negative on some occasion, which analysts say may have been for the first time in history.
With forward premiums coming down exporters also prefer to lend dollars, rather than sell spot or forward, market participants said. It is not clear how much the phenomenon is contributing to private credit.
According to Central Bank data in the week ending November 17, one month forwards were at 185.61 rupees to the US dollar and three months at 185.58 rupees, below the one month rate, despite the uncertainty.
In contrast in the week to January 24, before money printing began and in a month that the central bank bought about 90 million dollars on a net basis, one month forwards were listed as 181.90 rupees to the dollar and the three months were at 182.80, or a premium of 90 cents.
Sri Lanka authorities had previously blamed rupee bond exits for currency pressure, forgetting that for over six decades pressure on the currency came from domestic credit driven by monetized debt or liquidity injections.
Sri Lanka had monetized about 544 billion rupees over the past 11 months.
Reserve money has barely grown to 928 billion rupees by November 26, from 945 billion rupees at the beginning of the year.
Foreign investors sold most of Sri Lanka’s rupee bonds after a real effective exchange rate index targeting exercise over the past few years showed that monetary stability had ended.
Amid the 2020 liquidity injections, which had driven down interest rates and pushed up stock prices foreign investors had been able to exit stocks at higher prices.
Already about 1.8 billion dollars in reserves had been lost, mostly through the capital account, data shows though there was a private credit collapse until August allowing the central bank to purchase dollars. (Colombo/Dec04/2020-sb)