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Sri Lanka withdraws some excess liquidity

ECONOMYNEXT – Sri Lanka’s central bank has reduced some of the excess liquidity in money markets that helped trigger a currency fall, forex reserves losses and downgrade before private credit fell in April.

Excess liquidity in the interbank money markets shot up to 209 billion rupees on June 26, mainly due to monetizing debt and manipulating rates down, but also due to liquidity releases from statutory reserve ratio cuts.

About 1.3 billion US dollars worth liquidity was mopped up through forex reserve sales.

Sri Lanka’s private credit had slowed in April but sweeping import controls have been placed.

On June 30, 17 billion rupees of excess liquidity pumped through a term reverse repo deal for 88 days on April 06 was allowed to mature without being rolled over.

The liquidity will therefore not turn into credit and forex reserve losses and put pressure on the currency.

Another billion rupee deal expired on July 03 and another 4.5 billion rupees on July 07.

In Sri Lanka money is printed through term reverse repo deals mainly to target an overnight call money rate, which some analysts have identified as perhaps the biggest risk to the economy, after the end of a civil war as the country lost the protection of a policy corridor.

With a call money rate targeting, any spike in domestic credit results in large pro-cyclical liquidity injections which de-stabilizes a soft-dollar peg in peacetime. The stronger the credit recovery the bigger the hit on the currency, analysts have pointed out.

Sri Lanka’s overnight rates have now hit the 5.50 percent floor policy rate, a situation which generally points to weak domestic credit, despite a spike in the deficit.

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The central bank also appeared to have sold down some of its Treasury bill stock Friday to by about 8 billion rupees to 303 billion rupees and excess liquidity came down to 163 billion rupees from 173 billion rupees a day earlier potentially saving more forex reserves.

However the economic activity continues to b hurt by import controls. (Colombo/July07/2020)