Sri Lanka sterilizes forex interventions with outright cash
ECONOMYNEXT – Sri Lanka’s central bank bought Rs4.0 billion in Treasury bills from the market participants injecting printed money up to 59 days to offset (sterilize) foreign exchange interventions that had generated liquidity shortages.
Analysts say the move represents an effective loosening of monetary policy, compared to an earlier stance of only sterilizing interventions overnight, and refusing to accommodate dollar outflows for a longer period, even if money is now printed at a higher rate.
The central bank injected Rs500 million at 8.75 percent for 24 days, Rs300 million for 31 days at 8.90 percent, Rs1.2 billion for 38 days at 9.0 percent and Rs2.0 billion for 59 days at 8.75 percent, a lower rate than the money given for 38 days.
A pegged central bank generates liquidity shortages when it sells dollars to defend the currency in forex markets (unsterilized defence), when strong domestic credit push up imports.
A soft-pegged central bank will then sterilize or fill the liquidity shortage with printed money to prevent rates going up, boosting credit and worsening the pressure on the currency.
A hard pegged monetary authority will refuse to accommodate the dollar outflow and let interest rates move up, eventually keeping domestic demand and imports exactly in step with dollar inflows preventing balance of payments crises.
The cash was injected through outright purchases of Treasury bills by the central bank, but the immediate effect is the same as printing money through a term reverse repo auction which the central bank had done earlier.
Overnight cash injection keeps bankers on their toes forcing them to look for deposits and can be viewed as a little less harmful to the economy and the currency peg, than injecting money at longer tenures, analysts say.
"When the central bank buys bills outright from a bank and creates money, banks will have money to play around for two months and they no longer have to look for deposits," explains EconomyNext columnist Bellwether.
"Even though the rate at which money is injected is higher than the 8.50 percent overnight window rate, the accommodation of dollar outflows is now permanent and it represents a loosening of policy compared to the earlier stance of injecting overnight money."
"Even if a central bank injects money overnight, day after day, it ends up sterilizing a forex intervention."
"But when markets are short, any dollar purchases will automatically will also be sterilized by a reduction in overnight window borrowings.
"When cash in permanently injected, it will no longer happen and the Central Bank has to say good bye to any dollars spent in interventions. Of course the central bank can refuse to roll-over the debt when it matures, but this is uncertain."
After the permanent accommodation of interventions on Monday, the central bank announced auctions Tuesday to buy up to Rs10 billion of bills maturing in January and February.
Monday’s two months bills were sold at 8.75 percent, giving a good deal to the seller. In the secondary market, February 2017 bill were quoted around 9.00/25 percent, dealers said, though 3-month bills were auctioned at 8.60 percent.
Bellwether says though the damage done to the economy and the poor people, is the same, calling auctions to print permanent money is more transparent than an earlier practice of buying up 3-month bills at auction without making any disclosure. (Colombo/Nov22/2016)