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Oct 18, 2012 (LBO) - Sri Lanka's Central Bank will gradually sell down its Treasury bill stock, as they come up for maturity, Governor Nivard Cabraal said, in a move which can strengthen the island's rupee peg and increase foreign reserves.
Sri Lanka's Central Bank has a little over 200 billion rupees in Treasuries it acquired during a balance of payments crisis in 2011 and 2012 when it printed money sterilize liquidity shortages stemming from foreign exchange sales.
Cabraal said when bills at the Central Bank come up for maturity they will be sold to the market, instead of being rolled over.
He said the market conditions and interest rates development were right for it.
"There had been a reduction in the T-bill holding," he said. "We are not doing it deliberately we do not want to hold it (the Treasury bill stock)."
Sterilized Purchase
A sell down of central bank held Treasuries to the public will reduce liquidity in the banking system, and tighten the monetary system putting upward pressure on Sri Lanka's rupee peg and reducing inflation.
If the central bank had purchased foreign exchange during the week, a sell down of its bill stock will cause excess liquidity to disappear, in a "sterilized foreign exchange purchase".
A T-bill sell-down will stop the rupees from being given as loans by banks, kill demand and reduce the central bank notes (rupees) coming up for redemption in foreign exchange markets in the ensuing period.
A too rapid sell down of Central Bank Treasuries however can stop interest rates falling quickly, deny the use of inflowing foreign capital in the economy and prevent an economy from moving into a fast 'V' shaped recovery.
Crowding Out
In the aftermath of previous balance of payments crises, when a country is under an IMF program, a combined target of a floor on foreign reserves and a ceiling on reserve money forces Treasury bills to be sold, preventing interest rates from falling rapidly.
A third target on the budget deficit - in the form of a ceiling on domestic borrowing - create conditions in credit markets to make it possible for the first two targets to be achieved.
In a 2008 column, LBO's economics columnist fuss-budget labeled the process monetary crowing out.
The cashflows captured by sterilized foreign exchange sales, which results in permanent increases in foreign reserves are then used to buy Treasuries of reserve currency countries, like the United States or the EU, essentially bridging budget deficits abroad.
A foreign reserve build up therefore "crowds out" the domestic economy.
Steady Path
Sri Lanka however is not under an IMF foreign reserve target.
Cabraal says the Central Bank will not "actively pursue" the strategy of selling Treasury bills.
Sri Lanka is expected to grow 6.7 percent in 2012, a high rate compared to most of the world.
Cabraal says there is no need to push for a rapid recovery as the space has been created to allow for variations in growth.
Sri Lanka's bond yields have fallen sharply over the past several weeks, though rates bounced back somewhat this week. At the weekly Treasuries auction also rates moved up slightly.
Sri Lanka's rupee peg which weakened as much as 134 to the US dollar under pressure from sterilized foreign exchange sales has picked up to 128-129 levels so far.
After the 2008/2009 balance of payments incident the rupee which fell to 120 to the US dollar went back up to 110.
http://lbo.lk/fullstory.php?nid=1380736744
Sri Lanka's Central Bank has a little over 200 billion rupees in Treasuries it acquired during a balance of payments crisis in 2011 and 2012 when it printed money sterilize liquidity shortages stemming from foreign exchange sales.
Cabraal said when bills at the Central Bank come up for maturity they will be sold to the market, instead of being rolled over.
He said the market conditions and interest rates development were right for it.
"There had been a reduction in the T-bill holding," he said. "We are not doing it deliberately we do not want to hold it (the Treasury bill stock)."
Sterilized Purchase
A sell down of central bank held Treasuries to the public will reduce liquidity in the banking system, and tighten the monetary system putting upward pressure on Sri Lanka's rupee peg and reducing inflation.
If the central bank had purchased foreign exchange during the week, a sell down of its bill stock will cause excess liquidity to disappear, in a "sterilized foreign exchange purchase".
A T-bill sell-down will stop the rupees from being given as loans by banks, kill demand and reduce the central bank notes (rupees) coming up for redemption in foreign exchange markets in the ensuing period.
A too rapid sell down of Central Bank Treasuries however can stop interest rates falling quickly, deny the use of inflowing foreign capital in the economy and prevent an economy from moving into a fast 'V' shaped recovery.
Crowding Out
In the aftermath of previous balance of payments crises, when a country is under an IMF program, a combined target of a floor on foreign reserves and a ceiling on reserve money forces Treasury bills to be sold, preventing interest rates from falling rapidly.
A third target on the budget deficit - in the form of a ceiling on domestic borrowing - create conditions in credit markets to make it possible for the first two targets to be achieved.
In a 2008 column, LBO's economics columnist fuss-budget labeled the process monetary crowing out.
The cashflows captured by sterilized foreign exchange sales, which results in permanent increases in foreign reserves are then used to buy Treasuries of reserve currency countries, like the United States or the EU, essentially bridging budget deficits abroad.
A foreign reserve build up therefore "crowds out" the domestic economy.
Steady Path
Sri Lanka however is not under an IMF foreign reserve target.
Cabraal says the Central Bank will not "actively pursue" the strategy of selling Treasury bills.
Sri Lanka is expected to grow 6.7 percent in 2012, a high rate compared to most of the world.
Cabraal says there is no need to push for a rapid recovery as the space has been created to allow for variations in growth.
Sri Lanka's bond yields have fallen sharply over the past several weeks, though rates bounced back somewhat this week. At the weekly Treasuries auction also rates moved up slightly.
Sri Lanka's rupee peg which weakened as much as 134 to the US dollar under pressure from sterilized foreign exchange sales has picked up to 128-129 levels so far.
After the 2008/2009 balance of payments incident the rupee which fell to 120 to the US dollar went back up to 110.
http://lbo.lk/fullstory.php?nid=1380736744
