ECONOMYNEXT – Sri Lanka has begun permanently sterilizing forex market interventions with outright purchases of Treasury bills to print money into the banking system after rejecting an auction of Treasuries, official data showed.
The central bank printed a total of 13.27 billion rupees Wednesday to fill a liquidity shortage coming from dollars sold to intervene in the spot forex market and swaps in the forward market through which it had given exchange cover to state banks, effectively engaging in quasi-fiscal activity.
The central bank printed 1,134 billion rupees at rates as low as 25 basis points below the overnight 8.50 percent ceiling policy corridor to inject rupee reserves into the banking system for 127 days (about four months).
The weighted average rate was 8.64 percent, 10 basis points above the 3-month bill yield two weeks ago but above the overnight rate. This week’s auction was rejected.
Another 2.85 billion rupees were printed through the purchase of 141 day bills (3-month 20 days), at 8.6 percent, 10 basis points above the ceiling policy rate.
The weighted average yield was 8.63 percent, below the rate of the 127 day bill purchase.
Another 6.67 billion rupees were printed at rates as low as 8.5 percent for 148 days (4-months 28 days) 10 basis points below the ceiling overnight rate, but at a weighted average rate of 8.81 percent, which is above the overnight rates.
Another 2.6 billion rupees were injected for as low as 8.5 percent for 155 days (5 months 5 days) at a weighted average yield of 8.85 percent.
Sri Lanka’s banking system is facing a shortage of rupee reserves of about 120 billion rupees following interventions in the spot market and two swaps with the National Savings Bank that matured last month.
The central bank also injected 13.85 billion rupees through an afternoon overnight auction and banks borrowed another 13.89 billion rupees from the last-minute window at 8.5 percent. Another 14.7 billion rupees were injected at 8.22 percent, for 7 days.
The rupee came under pressure due to a policy error in July and August where the central bank provided a cash advance to the Treasury against dollars, expanding reserve money but not intervening to provide credibility to the dollar soft-peg at the spot leg at which money was created.
When the central bank buys bills outright banks can to do whatever it wishes with the printed money (including funding imports) with no further obligation unlike term reverse repo injections to sterilization which mature and has to be repaid.
But EN’s economic analysts Bellwether, says the liquidity shortage is so large that as long as about 30 to 40 billion rupee overnight cash shortage is maintained (about 4-5 percent of reserve money) the rupee will get support.
Ideally the rupee should be floated so that confidence is re-established in the peg and appreciated so that interest rates can fall naturally, speculation will end and businesses and people can go back to growth creating activities.
Bank overnight dollar positions should be restored so that the central bank need not intervene at the margin all the time and there is depth in the forex market.
High interest rates emerge during currency pressure because the central bank intervenes in forex markets sucking up liquidity and exporters borrow rupees for fund operations to stop converting dollars.
Injecting cash via market bill purchase is better than intervening in bill auctions directly as it is a more transparent process.
Bellwether says laws should be brought to prevent the central bank from injecting cash at rates below the Sri Lanka Interbank Offered Rate of the previous day for any tenor, prohibit giving forward forex cover to any market participant, and prohibit providing advances to the finance ministry through dollar swaps absolutely, so that the current administration or any future administration is able to pursue a free trade agenda.
Sri Lanka was forced to enact draconian exchange and trade controls, soon after the current central bank with a soft peg was set up in late 1950. Many countries faced heavy pressure from the US State Department to join the Bretton-Woods system of soft-pegs.
The US also lent a Fed official to set up the soft-peg.
In all soft-pegged countries which have monetary instability there is widespread ignorance about central bank operations and all problems are blamed on ‘imports’ or the budget deficit. Countries where there is knowledge about soft-pegs, do not go to the International Monetary Fund. (Colombo/Oct04/2018)