Feb 09, 2012 (LBO) – Treasury bills acquired by the Central Bank to back money printed to sterilize interventions in the forex markets to defend a dollar peg has topped 205 billion rupees, official data showed. The peg was adjusted down 30 cents to 114.60 rupees from 114.30 rupees on Thursday from a day earlier, dealers said.
During a balance of payments crisis in 2008/2009, the Central Bank’s Treasuries stock peaked at 225 billion rupees in April 2009 when the currency was clean floated ahead of a bailout loan from the International Monetary Fund.
The T-bill stock is the main component of the ‘domestic asset’ portfolio of the Central Bank which are used to collateralize money printed and injected to the economy, which results in an equivalent loss of foreign reserves.
When credit growth is high foreign reserves are also lost when money is printed and given to the government as ‘provisional advances’ at the beginning of the year and central bank profits are transferred to the Treasury, also at the beginning of the year.
Such transfers are not backed by Treasuries. When credit growth is high the central bank is also unable to sell down bills taken in return for foreign loans settled on behalf of the government, contributing to net foreign reserve losses.
Pressure on Sri Lanka’s dollar peg mounted from around the second quarter of 2011, but interventions were initially not sterilized to keep interest rates down.
Active sterilization began on September 2011. Before that the Central Banks’ T-bill stock was less than a billion rupees. By February 09, the Treasury bill stock rose to 205.3 billion rupees.
Another 17 billion rupees in cash was injected to the market on that day.
Sri Lanka has a so-called ‘soft-pegged’ exchange rate regime where a central bank unsuccessfully tries to target both the exchange rate and interest rate at the same time, creating foreign exchange shortages and full blown balance of payments crises.
A clean float of the currency is needed to end contradictory interest rate and exchange rate policy and stop sterilized interventions.
A prolonged balance of payments crises, eventually leads to a banking crisis.