ECONOMYNEXT – Sri Lanka’s primary dealers are making excessive use of the central bank’s standing facilities to fund their government securities portfolios though they have been cut off from liquidity auctions, an International Monetary Fund report said.
“Non-bank primary dealers for government LKR debt have access to standing facilities and routinely use Standing Lending Facility (SLF) to fund their portfolios,” the report said.
“The share of non-bank primary dealers in SLF accounts for about 46 percent or about 76 bn LKR as of end-April 2023,”
“Central Bank of Sri Lanka should start phasing out the use monetary instruments to support LKR bond market development.
“Monetary policy instruments should therefore not be made available to non-bank primary dealers to support their activity in LKR bond market.”
Primary dealers are already cut off from open market operation auctions.
Central banks of low inflation countries (with floating exchange rates, including the US) provide liquidity facilities to dealers.
The use of central bank standing facilities should only be used to clear transactions on a single day and are not expected to be used for days or weeks on end, analysts say.
Ideally any such borrowings should be cleared before the next auction by selling the securities to real investors.
In Sri Lanka due to the peculiar way Treasury bills are sold, including mandatory dumping of Treasuries on dealers in subsequent stages after the initial auction, dealers have no money to pay for them.
Memento mori
In a reserve collecting central bank, it is irrelevant whether inflationary open market operations provide money to banks, bank primary dealers, or non-bank primary dealers or the government directly.
The balance of payments will go into deficit and the government will lose the ability to repay maturing debt regardless to which counterparty liquidity is injected to mis-target rates.
In the case of private credit being re-financed through the open market operations, imports may be generated faster than through the government, since most government expenses are domestic in nature.
Banks which get central bank credit also lend without deposits to customers, triggering external imbalance, currency depreciation, exporter holdback, importer early covering, leading a spike in domestic credit and more injections.
State-owned banks have traditionally been the worst users of such facilities, while foreign banks generally have excess reserves.
If there was no policy rate, or a narrowly targeted call rate excess reserves leads to an automatic rise in foreign reserves of a hard pegged monetary authority, as it did before the central bank was set up in 1950.
Before 1950 any government deposits in the monetary authority also led to a rise in foreign reserves.
When a soft-pegged central bank (a central bank which creates chronic forex shortages and depreciation due to an already flawed operating framework and imposes exchange controls) injects money deeming there is a ‘structural shortage’ (usually after intervening in forex markets), it leads to a permanent loss of foreign reserves.
Any money banks that get by selling Treasury bills term or outright to the central bank will also re-finance domestic credit and leading depreciation (or a loss of reserves).
One advantage of allowing primary dealers to access auctions, however is the market credit conditions are quickly communicated to the central bank and the re-financing can rise quicker to to the ceiling rate and ward off balance of payments deficits.
Hi bid rates by primary dealers, can also signal the need to raise the ceiling policy rate in a reserve collecting central bank to stop the erosion of reserves.
Balance of payments troubles started to emerge in Western nations after the Federal Reserve invented the policy rate and open market operations in the 1990s.
Countries like Singapore, Hong Kong and lately Cambodia and GCC nations have avoided currency depreciation, severe banking crises, social unrest and political upheavals by not having a policy rate. (Colombo/Sept28/2024)