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Sri lanka News – Sri Lanka’s central bank has permanently injected about 130 billion rupees into the banking system by purchasing Treasury securities, data show, shortly after Governor Nandalal Weerasinghe said an overnight short will be reduced.

The central bank’s disclosed outright Treasury securities stock went up to 2,580.6 billion rupees on November 15 from 2,440 billion rupees a day earlier.

Sri Lanka central bank to ease liquidity short in banks: Governor

However overnight lending to banks through a standing facility at 15.50 fell to 154 billion rupees from 248 billion rupees leaving net credit into the banking system unchanged.

Sri Lanka’s intermediate regime central bank in triggering the worst currency crisis in its history did not inject cash into the banking system outright to sterilize interventions as it had done in the past.

As a result, banks had to borrow large volumes through the overnight window. In theory such an action should make banks restrict credit and stop the balance of payments crisis.

It is not clear whether Sri Lanka’s central bank has counterparty limits when injecting short term liquidity into banks.

In the 19th century when central banks were not allowed to create currency crises and hurt the poor as now, British classical economists like David Ricardo called such injections that trigger imbalances ‘fictitious capital’.

But after the Fed created the Great Depression, and the rise of Keynesianism, central banks were able to inject ‘fictitious’ capital, trigger mal-investment, balance of payments crises and high inflation, with impunity.

The permanent 130 billion rupees is injected when Sri Lanka’s market rates around 30 percent and private credit is negative.

Many cautious banks, especially foreign banks are no longer lending to either domestic banks in the interbank market, to customers or the government.

As a result about 344 billion rupees – capable of creating forex pressure around 500 million US dollars if loaned to customers – are parked in the central bank.

Such cash which are not loaned due to risk perceptions are sometime called ‘private sector sterilization’.

The term ‘liquidity trap’ also describes a similar situation.

In the Great Depression many customers wjho withdrew cash from US banks are said to have and buried them in proverbial coffee cans.

In the past liquidity shortages created by central bank sales of dollars to finance imports and filled overnight have been cleared by cash from dollar purchases after confidence in the currency was restored following a float.

Sri Lanka’s central bank no longer has reserves or a capacity to borrow to sell dollars to create what is called a ‘balance of payments deficit’, but through injections of cash it can still push the currency down if banks are willing to give credit.

Then central bank has used several tools to inject cash and make banks given loans without deposits, these include overnight injections, term injections, outright purchases of bonds (to mis-target bond yields).

A key tool is to rejects bid for bill auctions and buy up maturing bonds from past deficits (monetize the gross domestic financing requirement) all of which are then blamed on the current ‘budget deficit’.

In the current currency crisis, which ended in a sovereign default, price controls were placed on Treasuries auctions. The legality of the moves are unclear.

However the consequences of mis-targeting of rates violates section 5 (a) of the bank’s constitution which requires the Monetary Board to maintain ‘economic and price stability’.

If sufficient mal-investments had been created and the consumption collapse is big enough to trigger large volumes of bad loans the actions may also violate Section 5 (b) of maintaining ‘financial system stability’.

Classical economists have and analysts suggested that the power to manipulate rates through liquidity injections be taken away so that the exchange rate is fixed and the country will have East Asia style stability to grow and draw foreign investment.

The central bank has acquired a portfolio of 2.5 trillion securities outright in the course of financing the private sector (by sterilizing imports and rejecting bids to roll-over old bills) and the government as well as to offset reserve appropriations for debt repayment. (Colombo/Nov16/2022)


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