Sri Lanka kills some liquidity ahead of cash flood

July 01, 2013 (LBO) – Sri Lanka’s central bank has killed billions of rupees in excess liquidity ahead of a flood of new cash into the interbank money markets from a reserve ratio cut on July 01. Dollar sales by a central bank fails to strengthen an exchange rate and further weakens a currency peg only if the dollars sales are followed by purchases of Treasuries for domestic currency (a sterilized purchase).

On Friday the Central Bank sold a 5.0 billion rupees tranche of Treasury bills from its balance sheet at 8.42 percent and another 5.0 billion rupee tranche at 8.47 percent on Friday for settlement on July 01.

Market liquidity went down from a 13.4 billion rupees excess on Friday to 9.1 billion rupees short on Friday indicating a sell-down of Treasuries on Wednesday.

A 200 basis point statutory reserve ratio cut is to release about 35 to 45 billion rupees in new cash to the market on July 01.

The new cash unless sterilized by outright sales of the Central Bank’s Treasury bill stock could potentially result in a 300 million US dollar loss of foreign reserves if the exchange rate is defended or a further weakness in the rupee if dollars are not sold.

Liquidity can be killed either by the sale of Treasuries into money markets or dollars into foreign exchange by a central bank to strengthen a peg.