Sri Lanka slashes bank NOPs after creating money through swap
ECONOMYNEXT – Sri Lanka’s central bank has slashed dollars held for trading overnight by banks called Net Open Positions, dealers said after the rupee fell from the pressure of tens of billions rupees generated from a currency swap over the last few weeks.
The rupee recovered to 161.65/75 to the US dollar in late afternoon trade after falling as low as 162.50 the US dollar in intra-day trading Thursday, dealers said, after harsh NOP limits were slapped on several commercial banks.
Sri Lanka’s rupee started to fall again over the last few weeks after the central bank generated tens of billions rupees through a swap expanding money supply, going against a stated policy of keeping a ‘flexible exchange rate’ analysts say.
Analysts had warned the central bank not to purchase dollars from the Treasury to create liquidity, alter the monetary base and then put pressure on the currency and instead transact official dollars for existing rupees. (Sri Lanka should stop surrendering Treasury dollar inflows to the Central Bank: Bellwether)
Creating money through a dollar/rupee swap is the same as buying dollars. Full pressure on the currency usually comes 4 to 6 weeks after a liquidity shock, analysts say.
The rupee came under severe pressure in May after a liquidity shock was created in late March and early April through a combination of terminated repo deals and reverse repo injections.
This time the liquidity shock was created through a dollar swap, authoritative sources said.
Though the swap is expected to be reversed, the rupee has since fallen by about 2.0 rupees to the US dollar, because a policy of ‘flexible exchange rate’ was followed after generating the liquidity, at a fixed rate like a peg.
The liquidity was neither fully sterilized with outright Treasury bill sales nor was credibility of the peg maintained by selling dollars. Analysts have previously pointed out that cutting NOP limits will reduce the depth of the forex market and worsen volatility.
Economists and analysts have called for the central bank to be abolished to stop the rupee from depreciating and creating economic and political instability or at least putting the brakes on the domestic operation department and the more damaging and inconsistent policies of the soft-peg.
The central bank through its loose or inconsistent policy, has depreciated the currency since 1951, keeping nominal interest rates un-necessarily high, destroying real wages and making ‘cost of living’ the main issue in political discourse. (Colombo/Sept06/2018)