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Sri Lanka takes most of sovereign bond proceeds out of the economy

ECONOMYNEXT – Sri Lanka has sterilized or taken out of the real economy, about billion US dollars of liquidity from a 1.5 billion US dollar bond sale, ensuring that the proceeds are not available to drive domestic credit, consumption and imports, but other newly minted money remains.

The Central Banks’ Treasury bill stock or domestic assets taken into to its balance sheet to print money and generate a balance of payments crisis and currency depreciation was sold from 229 billion rupees to 82.6 billion rupees.

The Central Bank also sterilized the proceeds of a 330 million dollar floating rate bond on October 19, taking rupees generated to purchase dollars from the Treasury, out of the banking system and the real economy.

Such ‘sterilized foreign exchange purchases’ remain permanently in foreign reserves (as the liability created to the domestic banking in the form of zero coupon rupee notes have been taken out by selling down the Treasury bill stock of the monetary authority).

The reserves can used as a show confidence, given to the government to repay loans and settle the Central Bank’s own liabilities to the Reserve Bank of India or the International Monetary Fund. A 400 million dollar swap with the RBI was due to mature last month.

However excess rupees in the banking system remain high at 123 billion rupees (which is about a quarter of the defined monetary base), after the Central Bank printed money to repay rupee bonds and avoid sovereign default on November 02, when a large tranche of rupee gilts matured.

There were substantial foreign holdings in the maturing tranche.

Any rupee liquidity which has been created and not sterilized (mopped up by domestic operations) will come up for redemption in foreign exchange markets as the notes are spent by their recipients (repaid bondholders) or if the banks where liquidity is deposited loaned them to new customers.

Despite the 1.5 billion US dollar bond sale, the potential immediate and near-future pressure on the rupee has increased by around 40 billion rupees or close to 300 million dollars from last Friday to this Monday.

Excess liquidity went up from 72 to 82 billion rupees after an estimated 14 billion rupees were printed to repay maturing bills on Friday October 30 and it climbed to 123 billion rupees on November 02 as more money was printed to repay longer term bonds.





The Central Bank will have to aggressively sell foreign reserves to defend the peg and ‘mop up’ the liquidity in the foreign exchange market to prevent the rupee from falling and generating poverty.

Any ‘sterilized foreign exchange purchases’ which do not contribute to new domestic credit, imports and inflation will also not help lower gilt of general interest rates.

If any liquidity from bond proceeds are sterilized by early repayment of Treasuries to the Central Bank, such money will also not be available to bridge the deficit in the first instance.

However if the money is used by the Treasury and liquidity from other customer accounts are sterilized (such as when salaries are paid or construction contracts are repaid) by selling Treasuries to commercial banks, potential private credit will be curbed.

The effect then will be almost the same as if the government borrowed the money domestically.


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