ECONOMYNEXT – Sri Lanka’s central bank has pumped 240 billion rupees in liquidity into the banking system an official said of which 140 billion rupees (the equivalent of about 695 million dollars in pre-liquidity injection exchange rate) had been to fill a spike in real money demand.
“We have pumped about 240 billion rupees in the banking system in the,” Deputy Central Bank Governor Nandalal Weerasinghe told Sri Lanka’s Derana television.
“Of that 140 billion rupees had gone to the people. That means people are keeping the money in their hands for use.”
The cash drawn down is probably the largest seen in the history of Sri Lanka’s banking system.
Sri Lanka sees large cash draw downs during April and December holidays, but the Coronavirus crisis had increased the demand for cash.
Any cash drawn down is a real demand for money and does not destroy the rupee peg with the US dollar by artificially lowering interest rates and pushing up excess liquidity.
The money is effectively disappears from the credit system, a phenomenon classical economists call ‘private sector sterilization’ of money printed by a central bank.
Cash drawn does not pressure a peg with the US dollar and there is no need to defend the currency by selling foreign reserves.
But the other 120 billion rupees have been sloshing in the banking system, depressing rates, at a time when total dollar inflows and outflows have also narrowed, until mopped up by dollar sales.
Sri Lanka’s soft-peg with the US dollar fell from 182 to the US dollar before the injections to close to 200 to the US dollar during April. On April 09, the rupee gained sharply amid dollar sales from the state bank, dealers said.
Sri Lanka also cut policy rates starting from January 30 and injected money through a reserve ratio cut.
“We cut policy rates before any central bank in the region,” Weerasinghe said. “Through several cuts we have brought down the policy rate by 100 basis points.”
Sri Lanka’s policy corridor is now 7.00 and 6.00 percent but the central bank targets a narrow mid-point with excess liquidity, losing the protection a corridor usually gives a pegged exchange rate, analysts have said.
Under the last Governor Indrajit Coomaraswamy in addition to targeting a call rate with excess liquidity an earlier protection brought by ex-Governor A S Jayewardene of prohibiting long-term bond purchases were removed.
The policy corridor was also narrowed by 50 basis points.
The Treasuries stock of the Central Bank had gone up from 69 billion rupees on February 19, 2020 to 78.3 billion rupees in the beginning of March to 182 billion rupees by the end of March and 263 billion rupees by April 10.
In February another 24 billion rupees was over-issued by a central bank profit transfer and in March over 50 billion rupees was dropped in to the system by a 100 basis point reserve ratio cut, in another ‘helicopter drop.’
Another 50 billion rupee loan facility has been set up with central bank credit in a quasi-fiscal operation.
Central bank refinanced credit (printed money) operations were halted by then-Governor Jayewardene as they contributed to the monetary instability seen in the 1980s preventing the country from gaining the full benefit of the post -1977 opening of the economy.
Sri Lanka’s economy was closed until then after the Bretton Woods system of soft-pegs collapsed in 1971-73 as the US printed money despite having a soft-peg with gold.
President Nixon then slapped trade controls (Nixon shock), which were soon removed and the dollar was free floated preventing the need for defending and injecting cash to maintain a policy rate.
Sri Lanka closed the entire economy until 1977. The central bank has in the past few weeks had also slapped controls and tightened exchange controls. (Colombo/Apr11/2020)