Sri Lanka pays back money printed in April

Sri Dharanee Performance Arts Theatre

May 01, 2012 (LBO) – Sri Lanka’s Treasury has repaid most of the money borrowed from the banking system including printed money from the Central Bank to meet seasonal salary needs of state workers, a top official said. “Instead of Treasury bonds and long term securities there has been a preference for to less than one year Treasury bills in the market,” he said.

“And that Treasury bills has also primarily are from the banking and central bank sources, because of the short notices we have to manage particularly in March and also for first few days of April for which we raised money for payments as a result there is an increase in the Central Bank holding (of Treasury bills)”

In April, demand for cash also goes up (the notes in circulation component of reserve money) as people withdraw money from banks to spend during the festive season.

In most years therefore excess liquidity builds up in the banking system after April when the money comes back to banks, unlike this year, when large volumes of excess liquidity remained in the banking system, throughout the period.

To prevent the extra money from creating inflation and exchange rate pressure, it has to be permanently mopped up, either through non-sterilized forex sales (which does not require a rate increase), or a through a sell down of the Central Bank’s Treasury bill stock, which may require higher interest rates.

Last week the rupee came under renewed pressure and forex dealers were accused of ‘speculation’.

But following (non-sterilized) sales of forex by the monetary authority excess liquidity came down from 29 billion rupees on March 23 to 10 billion by March 26.

Unlike sterilized forex sales, where new rupee reserves are injected into banks allowing them to keep extending credit, creating fresh demand and imports, non-sterilized interventions (which destroy liquidity) do not put new pressure on the exchange rate.

In countries like Hong Kong, where the monetary authority only engages in non-sterilized interventions the exchange rate remains fixed. In such countries, seasonal cash demands (such as during the Chinese New Year) is met by banks running down their excess reserves.

By April 30, the central bank’s T-bill stock had also reduced to 233 billion rupees.

Though excess liquidity was driving the currency down, analysts say forex markets were also under a mistaken assumption that ending Central Bank forex sales for oil will pressure the currency, which had undermined credibility in the peg.

Analysts say a key reason for the continued fall of the rupee after February, were sterilized sales of foreign exchange for oil payments, and ending such sales would take pressure off the peg.

Meanwhile Jayasundera said central bank interventions by the central bank in February and March were less than 200 million dollars a month.

Corrected: repayments of T-bills to banking system Rs38bn not Rs30bn Treasury secretary P B Jayasundera said out of a 40 billion rupee one month Treasury bill sold in to the banking system, including the Central Bank, on April 10, 38 billion rupees had been paid back by last Friday.

“The nature of this country’s economic behavior is the government pays the salaries of March on the 25th of March and April salary and pensions on or before the 8th of April,” Jayasundera told reporters.

“So all the monthly requirement, the seasonal requirement has to be at once. Not only government does that, even the private sector does that and then you close the shop.

“In that context the market cannot generate so much short term liquidity in such a short time.”

By April 16, the Treasury bill stock of the Central Bank shot up to 265 billion rupees from 214 billion rupees at the end of March.

Excess liquidity in the banking system rose to 31 billion rupees on April 16 from 19 billion rupees at the end of March as new rupee reserves were injected to the banking system.

Jayasundera said there was also general preference for short term instruments as market participants expected rates to go up amid foreign reserve depletions and liquidity shortages.