Sri Lanka’s central bank lends liquidity near deposit rate

ECONOMYNEXT – Sri Lanka’s central bank is injecting billions of rupees (lending money) to the banking system the rate at which excess liquidity is taken out, data from the monetary authority shows.

The central bank loaned 14.9 billion rupees to the banking system into the banking system on August 09 at a weighted average yield of 7.78 percent, or 28 basis points above the standing deposit facility at which excess money is withdrawn.

Some cash was loaned at a rate as low as 7.70 percent or 80 basis points below the standard lending rate.

Sri Lanka is now recovering from monetary instability in 2018, triggered by tens of billions or excess cash injected into the banking system from late March 2018, and another liquidity shock from unsterilized liquidity from around August.

The interbank market has had excess liquidity from dollar inflows amid weak domestic credit, allowing overnight rates to fall near the floor of the policy corridor 7.5 percent.

Until last week the central bank was withdrawing liquidity at around 7.70 percent, 20 basis points above the deposit rate.

Excess liquidity in Sri Lanka’s interbank system is usually skewed towards foreign banks (have a reserve ratio higher than specified), while domestic banks tend to overtrade, lending beyond their deposit, analysts have said.

Analysts have called for the policy corridor to be wide, to help prevent currency pressure, given the past record of the domestic operations department and a perceived obsession with short term rates.

In 2018 February the central bank’s domestic operations department suddenly halted sterilization auctions and then started to release liquidity by terminating term repo deals just as the economy and credit system recovered.

The central bank is planning some reforms to its risky money printing operations including outlawing direct purchases of Treasury bills from auctions.

There have been calls to criminalize certain liquidity operations including a so-called buffer strategy involving using bank lender of last resort facilities to repay bonds and swaps which involve forward exchange guarantees as well as liquidity accommodation.

In East Asian countries with the best monetary stability, central banks are banned from giving forward exchange cover.

Sri Lanka’s economy was progressively closed after a soft-pegged exchange rate regime was set up In 1950 to join the failed Bretton Woods system.

The economy was completely closed after the Bretton Woods soft-pegs collapsed in 1971. (Colombo/Aug13/2019)