Sri Lanka central bank promises vigilance over liquidity as inflation rages

Nov 20, 2007 (LBO) – Sri Lanka’s central bank said it is countering a liquidity shock to the monetary system from a dollar bond issue, though policy rates frozen at 12.0 percent remained negative compared to raging 19.6 percent inflation. A sudden conversion of 500 million dollars worth state borrowings in late October drove up money supply with excess liquidity to more than 10 percent over the central bank’s reserve money targets from October 24.

Excess Liquidity

This dismayed central bank watchers who had earlier expected a positive effect on demand pressure from the foreign borrowing.

“In order to neutralise any build up of demand pressures in the economy and curtail the demand driven inflation arising from excess liquidity, the maintenance of liquidity at a desirable level is warranted,” the Central Bank said in its November policy statement released Tuesday.

The monetary authority said “the required steps would be taken “as and when necessary”.

The excess liquidity from the bond had now been siphoned off through open market operations, the Central Bank said.

The Central Bank said the dollar inflow had helped stabilize both interest rates and exchange rates.

Negative Real Rates