Sri Lanka Treasuries auction fails; renewed fears for rupee

ECONOMYNEXT – Sri Lanka’s Treasuries auctions failed on Wednesday with all bids rejected for a Rs25 billion of bills on offer, data from the state statistics office showed, renewing concerns of pressure on the rupee.

At least Rs19.9 billion of bills were maturing this week, according to market estimates.
 
Sri Lanka’s bond yields edged up over the past week about 20-25 basis points, and dealers say they bid higher.

In addition to some concerns over possible tax changes to the call money markets, there have also been some foreign selling in bond markets, dealers said.

The debt office, which is a unit of the Central Bank, offered Rs7.4 billion of three-months bills, Rs9.3 billion in six-month bills and Rs16.3 billion of 12-month bills for auction.

On Wednesday, the Central Bank injected Rs45 billion in the banking system through a reverse repo auction to sterilise forex interventions made earlier.

If all the bills are bought with printed money, billions of rupees of liquidity will be permanently injected to commercial banks, validating a liquidity short that has already occurred and reducing the liquidity short permanently.

If bills are not bought with printed money, banks will raise deposits to reduce their borrowings from the Central Bank, curbing potential credit, allowing the Central Bank to buy dollars, rebuild lost forex reserves and fill the liquidity shortage.

But if bills are bought with printed money, the foreign reserve loss will be permanent, with maturing bills of customers being ‘turned into money’, driving credit and inflation up and pushing the rupee lower.

The bill rejection comes as there were signs that Sri Lanka’s balance of payments crisis, triggered by the purchase of 250 billion rupees of bills to keep rates down, was beginning to end. The central bank bought dollars and sold down about 50 billion rupees of bills.

The volume of printed money that needs to be injected this week will depend on the portion of the maturing bills already held by the central bank and the ability of the Treasury to repay bill holders with any excess cash it has.

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Repaying bills with Treasury money does not cause balance of payments pressure or inflation, but will reduce crowding out of private sector credit.

Analysts say the central bank’s tendency to buy Treasury bills to stop rates going up, driving up credit, where quantity easing is believed to occur at a rate equal to the 3-month bill yield at the last successful auction is the deadliest monetary policy tool at the disposal of the agency.

EconomyNext’s policy analyst Bellwether compares pegging of the three month Treasuries yield by Sri Lanka’s central bank to create ‘cheaper and cheaper rupees’ to the Federal Reserve pegging the yield of long-term bonds at 2.5 percent, to create ‘cheaper and cheaper dollars’ in the 1950s under pressure from the Treasury.

The Fed shook eventually off fiscal dominance by getting the independence not to peg rates deeper into the yield curve, saving the Bretton Woods peg system from immediate collapse.

"[We are making] it possible for the public to convert Government securities into money to expand the money supply.. ., Federal Reserve Governor Mariner Eccles said at the time.

"We are almost solely responsible for this inflation.

The Federal Open Market Committee wrote to then President Harry Truman at the time, pointing out that the purchase of Treasuries was weakening the dollar and driving prices up.

"Today’s inflation …is due to mounting civilian expenditures largely financed directly or indirectly by sale of Government securities to the Federal Reserve.. . ," the letter said.

"The inevitable result is more and more money and cheaper and cheaper dollars.

Analysts say buying Treasury bills to peg the three month bill yield, is the ‘elephant in the room’ monetary policy tool in Sri Lanka that is not formally mentioned in economic literature.

Analysts say it is not clear whether the central bank is legally empowered by its governing law to peg a Treasury bill yield other than the overnight interest rate or buy bills in large quantities to inject money and de-stabilize the credit system, the rupee and eventually the economy. (Colombo/Oct12/2016)
 

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