Jan 07, 2009 (LBO) – Sri Lanka’s central bank will borrow Treasuries from long term fund for money market operations, giving pension and insurance firms a chance to make more fee income, Governor Nivard Cabraal said. By late 2009 the Central Bank ran out of Treasury bills, though the stock rose during December towards 30 billion rupees.
But excess reserves in the banking system were also a similar amount, and had been sterilized or drained by selling central bank securities. The central bank has also used foreign exchange swap deals to drain liquidity.
“There are certain limitations of Central Bank securities as instruments to absorb excess liquidity as we have seen in the course of the year,” Cabraal said.
Central Bank securities are issued by the monetary authority at its own interest costs, but some foreign banks in particular had exposure limits, which reduced the secondary market liquidity of the instrument.
This prevented CB securities from being used as perfect substitutes for Treasuries.
A central bank with a free floating exchange rate will not run out of Treasury bills as the entire money supply is backed by government credit or domestic assets.
But a soft-pegged exchange rate central bank that collects foreign reserves greater than its domestic monetary base can run out of domestic assets.
Sri Lanka’s central bank also has tens of billions of provisional advances due from the Treasury which has not been settled. “We have now planned to introduce a program to borrow government securities for open market operations on a repo basis from long term investors such as the EPF (employee’s provident fund) and insurance funds as well,” Cabraal said.
“It will provide avenues for such investors to earn fee income for their idle securities while at the same time government securities thus borrowed can be sold on repo basis to mop up excess liquidity effectively.”
“Borrowing of securities is a standard practice.”
Cabraal was delivering a speech outlining the country’s monetary policy direction for 2010 this week.
After buying up more than 200 billion in government securities to print money and inject liquidity during the 2008 balance of payments crisis, the Central Bank started selling down its Treasury bill stock after the currency was floated in April.
After April the Central Bank started to drain liquidity as foreign capital flocked in amid renewed confidence in Sri Lanka’s peg with the US dollar.