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Friday October 7th, 2022

Sri Lanka’s central bank ‘saves’ US$27mn in forex reserves

ECONOMYNEXT – Sri Lanka’s central bank has sold down 5.6 billion rupees from its Treasury bill portfolio potentially saving 27.6 million US dollars at a peg (convertibility undertaking) of 203 to the US dollar, official data shows.

On July 16, 2021, the central bank sold down its Treasury bill stock to 911.44 billion rupees from 917.05 billion a week earlier following a successful Treasury bill auction.

The central bank offered 56 billion rupees in bills at last week’s bill auction and sold all of it, though most came from the 3-month end.


Sri Lanka sells all bills at Treasuries auction

A week earlier also there was a 4 billion rupee sell-down of bills.

The central bank has bought hundreds of billions of rupees Treasury bills by injecting new rupee reserves into banks (printing money) boosting loans, investments and consumption above the dollar inflows to the country.

Sri Lanka has imposed exchange controls and import controls after injecting rupee reserves into banks. However the trade deficit in the first five months of the year exceeded the 2019 level as credit flowed into new areas.

Instead of limiting liquidity injections and slowing domestic credit to balance inflows with outflows (or selling down bills to collect reserves on a net basis to repay debt), the central bank injected liquidity driving credit and imports.

During the five months to May 2021 the trade deficit was 3.6 billion US dollars, up from 3.1 billion US dollars in 2019 when the central bank was following deflationary policy selling down its T-bill stock up to July.


Sri Lanka import controls shattered by credit, money printing in May

Sri Lanka raises de facto policy rate 02bp to 5.25-pct

When the new rupees hit the forex market, the central bank has to sell its dollar reserves to maintain the exchange rate and ‘redeem’ the rupees to maintain the peg running down forex reserve on a net basis.

The central bank last week raised its ceiling rate by 02 basis points for Treasury bills which has became the key de facto policy rate through which most of the money was injected to the market in 2020 and 2021.

The rate was seen to inject or withdraw money, effectively sterilizing in both directions in recent months either withdrawing or injecting liquidity.

“The apparent blind sterilization goes to show that the short term gilt yields are being used as a final target,” EconomyNext economic columnist Bellwether says.

“There have been also claims made by authorities that keeping rates down has helped save interest costs on government debt. Actually what happens is that a given convertibility undertaking or peg foreign reserves are run down.

“It is the same as financing the deficit through central bank forex reserves, except that there is high level of monetary instability and the peg also breaks.”

Sri Lanka set up a central bank with a non-credible peg (anchor) at 2.88 grains to gold in 1950 abolishing a credible peg maintained by a currency board arrangement from 1885.

The hard was peg initially set up against the Indian silver rupee, before the creation of the Reserve Bank of India. RBI, sometime after its creation also shifted its anchor to gold.

Sri Lanka’s forex reserves have been steadily eroded since August 2019 after liquidity injections began under an ‘output gap targeting’ exercise and sharply ratcheted up in 2020 under so-called Modern Monetary Theory, a type of un-anchored monetary policy.

Of late the central bank has decreed a 203 non-credible convertibility undertaking for banks, but is not giving dollars to back it up, leading to rationing of dollar for current account transactions, leading to parallel markets.

But the central bank is selling dollar to the Finance Ministry to repay loans, enforcing the convertibility undertaking through the financial account, leading to forex reserves.

When liquidity is injected to the banking system to give loans, in excess of deposits and loan repayments, the resulting cascading expansion in domestic credit, triggers an outflows of foreign exchange in excess of inflows.

The sell down of central bank held securities, which withdraws liquidity (contractionary sterilization or deflationary policy), pushes short term rates up, slows credit and reduces outflows.

But the banking system however has 61 billion rupees of net excess liquidity, with 45 billion rupees also borrowed from the overnight window at 5.5 percent.

Sri Lanka started the year with 266 billion rupees of excess liquidity which have been drained through mostly convertibility provided to loan repayments.

Some cash has also been absorbed by also been an expansion of reserve money as inflation picked up and demand for cash went up partly for precautionary reasons.

In 2021 another 45 billion rupees had been injected through a so-called temporary provisional advance, a tool built by the creator of the central bank, Fed money doctor John Exter, to block permanent injections of rupees.

However the central bank started to buy Treasury bills on a long term basis, shortly after he left the bank and created the first currency crises as the US Fed fired a commodity bubble purchasing Liberty Bonds around 1951.


Sri Lanka’s central bank should guard against bankruptcy as Fed lights commodity fires

Global commodity prices, including oil, are now rising due to the ‘Powell bubble’ fired by the US Fed contributing to overall monetary instability and analysts have warned that the central bank’s dollar liabilities may exceed its assets. (Colombo/July19/2021)

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