ECONOMYNEXT – Sri Lanka’s central bank has defended its inflationary open market operations where money was injected to overtrading banks has ended up as excess liquidity of 200 billion rupees in its deposit window by October 29.
Barely a month ago deposits in the window was around 100 to 120 billion rupees.
That was because foreign banks which did not lend in interbank market due to risk limits. This has been well reported earlier. But the volumes came down as confidence increased.
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However, by freely injecting money to overtrading banks, this amount has now gone up to 200 billion rupees.
While some of the money comes from central bank purchases of dollars, the liberal open market operations are also responsible for the balance.
The central bank in an explanatory note has said that if it did not do so, interest rates would have gone up to very high levels.
However, that is a highly misleading statement. Due to its standing facility overnight rates cannot go above 9.25 basis points.
The central bank in it explanatory note has said that money printing is buying securities from the primary market for Treasury securities which has been prohibited under the new law and that open market operations are a standard or normal practice.
However, Sri Lanka’s central bank for many years until there was a public outcry from around 2004 onwards, especially in the financial media, buying direct at auctions was also considered standard practice. In countries with chronic monetary troubles, many practices considered ‘normal’.
In fact, it may be recalled that at one time the central bank also used to publish the volume of its take-up at each Treasuries auction and the disclosure suddenly stopped.
It may be recalled that when the media started to question outright purchases, similar denials were issued. These statements are available for anyone to see.
Here is an example
It must also be recalled that during the time of Governor A S Jayewardene and for several years later the daily disclosed central bank treasuries stock included open market operations volumes.
The statement also claimed that reserve money (as defined) has not increased. This is also a claim that was made in the last crisis, when the media and other analysts protested the rising injection of liquidity by the acquisition of Treasury bills, which was leaking as foreign reserve losses.
In addition, the way Sri Lanka’s reserve money is defined, the aggregate overnight balance (at the very least) is not included in reserve money and therefor when overnight liquidity rises, it does not show up in ‘reserve money’.
That is why, when the SRR is cut, the very next day, reserve money appears to drop, even though the money is the available for final clearing of transactions in the economy.
Injecting money far below its lending facility rate (including two basis points above the standing deposit facility rate) is an extremely questionable practice when its lending rate is supposed to be 9.25 percent.
Having said all that, as the column itself explained, the central bank has done a very good job for over two years where it was in fact ‘unprinting money’ and providing external stability to the country.
Some of the earlier injections were to partly compensate for over selling Treasuries.
However it is an increasingly risky practice to engage in when the economy and private credit recovers.
That is why Sri Lanka (and other countries with flawed operational frameworks) have balance of payments troubles when the economy is doing well.
It is very good that these debates are taking place. It is to be hoped that like the discourse that started over 15 years ago on auction purchases, the debate on open market operations will lead to more circumspect domestic operations in the future and perhaps legal restrictions as well.
At the very least open market operations beyond one day should be on a upward sloping penal interest rate curve, not below the overnight rate as is happening now.
It must also be noted that that that until the new law, aggressive open market operations were not required to push down rates and trigger forex shortages (when private credit picked up) because the central bank could freely purchase bills at the auction.
The full statement by the central bank is reproduced below: