Sri Lanka banking system liquidity up on bond sales

July 26, 2012 (LBO) – Sri Lanka’s central bank has announced a record repo auction of 58 billion rupees to drain excess liquidity from the banking system dealers said, indicating that proceeds sovereign bond had been used to repay short term bank debt. The liquidity also indicates that over 400 million US dollars from a billion US dollar sovereign bond had by-passed foreign exchange markets and had been given to the Central Bank in return for rupees.

Sri Lanka’s finance ministry runs large overdrafts at state commercial banks and uses foreign loans to pay down the debt, creating excess liquidity in the banking system.

Analysts have warned earlier that such actions had tended to weaken Sri Lanka’s rupee peg in the past and also push inflation up as the newly created loans increase credit volumes in the economy.

To keep the exchange rate from depreciating, the Central Bank has to either sell down its newly collected foreign reserves in unsterilized transactions or sell down its Treasury bill stock outright to mop up the liquidity.

The International Monetary Fund has also expressed concern at large liquidity volumes that mushroom in the banking system from unsterilized foreign exchange purchases.

The spot US dollar was quoted at 130.90/131.10 on Thursday, dealers said.