July 30, 2012 (LBO) – Sri Lanka’s Central Bank has sold outright 1.2 billion rupees from its 220 billion rupee Treasury bill stock to kill some of the liquidity that came from the purchase of dollars from a sovereign bond. The Central Bank said it had got bids for 850 million rupees for an offer to sell 7.5 billion rupees of bills maturing in 17 days. The monetary authority has accepted bids of 550 million rupees at a weighted average yield of 10.91 percent.
For the offer to sell 8.0 billion in 24-day bills, the Central Bank has got bids of 1.12 billion rupees and it had accepted bids worth 728 million at 10.94 percent.
Unlike Sri Lanka’s weekly Treasury bill auction, where the Central Bank’s public dept department sells securities on behalf of the finance ministry as an agency function, outright sales is domestic operation on its own account.
Such a sale triggers a contraction of reserve money (the monetary base).
A primary auction of Treasury bills simply moves money from a commercial bank to the Treasury account of a state bank from which the state then spends it eventually creating import demand.
But money used by a bank or the public to buy bills from central bank ‘disappears’ from the economy forever. The Central Bank can then ‘lock up’ an equivalent amount of dollars in its foreign reserves.
A transaction where rupees generated from a purchase of dollars are extinguished or sterilized by the sale of securities is a sterilized foreign exchange purchase.
Such transactions can increase foreign reserves, strengthen an exchange rate peg, reduce the trade deficit (from the potential) and reduce the current account deficit of the balance of payments.
In the year to December 2011 the Central Bank bought 167 billion rupees of Treasury bills either through rupee injections or loaning reserves to pay for foreign state loans widening the trade and current account deficit about 3.0 percent of gross domestic product more than it would have otherwise been.