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GoSL Buys $ 142 Mn From CBSL’s Reserves

  • To Meet External Commitment

Central Bank of Sri Lanka (CBSL) infused Rs 20,000.18 million worth of liquidity to the Government of Sri Lanka (GoSL) on Monday (May 20) to assist GoSL to meet an external commitment of Rs 17,960.18 million (US$ ($)142.2 million which was met from CBSL’s reserves, data showed.
In this mechanism, GoSL supported by CBSL indulged itself in submarket operations in order to protect the Exchange Rate (ER), but at the expense of market liquidity, which opens the doors for pressure to once more bear upon interest rates in the absence of adequate inflows.
The tight liquidity situation prevailing in the market may be best exemplified by the fact that the weekly Treasury (T) Bill auction, this time held on Tuesday (May 21) on account of the short week due to the Vesak holidays, saw the weighted average yield (WAY) after tax of the 364 day (one year) benchmark T Bill tenure rising by two basis points to 10.86% week on week, after the yields in the previous weekly auctions that preceded, having declined steeply.
To overcome this illiquid situation prevailing in the market, CBSL at Monday’s (May 20) money market trading injected Rs 10,000.18 million to the economy by subscribing to T Bills, an obvious indication that the culprit behind the market’s illiquid situation is GoSL.
When the State’s borrowing costs are high, CBSL obliges the government by buying T Bills at no borrowing costs to the State, in contrast to the market subscribing to T Bills, which however demands interest for such investments. But this action of CBSL subscribing to T Bills in turn floods rupee liquidity to the market, with a possible reaction to this being demand side inflationary pressure emanating from the market.
This cash injection by CBSL also comes in the backdrop of further Rs 10,000 million having had been injected to the economy through a term reverse repo auction held by CBSL, which settlement took place the same day, i.e., on Monday.
Therefore, the market, in total, enjoyed Rs 20,000.18 million cash infusion on Monday, but returned a surplus of only Rs 2,040 million at the end of the day’s trading. This surplus may be observed from CBSL’s repo borrowings made on the same day, which was a sum of Rs 2,040 million.
Meanwhile, the reason why the market’s final excess liquidity (Rs 2,040 million) didn’t match Monday’s liquidity injection of Rs 20,000.18 million was because of further State borrowing, this time in the form of a submarket operation, because of which the market’s excess liquidity in total didn’t remain in the system, leaving only a balance of Rs 2,040 million behind in the form of repo borrowing (excess liquidity).
The reason why this Rs 2,040 million is termed as excess liquidity is because another 8% of banks’ excess liquidity equivalent to the value of customer deposits is held by CBSL as security, but giving banks no returns whatsoever. Part of this excess liquidity, equivalent to 2% of banks’ deposits or so, may be held in the form of cash deposits in commercial banks’ vaults, while the remaining 6% have to come from the banks’ reserves. Therefore, this excess which is available for banks’ trading activities is the ‘excess’ of that excess liquidity (i.e., 8% of the value of banks’ deposits that have been deposited or reserved with CBSL as security) which is available over and above the statutory reserves ratio requirement of 8%, as that percentage is referred to, for such interbank lending works.
Assuming that market’s inflows received on Monday were not converted, thereby ensuring that there were no rupee inflows into the market, then the deficit in the market’s excess rupee liquidity may be attributed to a submarket operation exercised by the GoSL in conjunction with CBSL in order to meet an external commitment, such as the settlement of an oil bill or foreign debt servicing or to meet the cost of an import of a defence store, or due to a mix of two or all three of these needs, where such foreign exchange (forex) procurements were made without disturbing the activities of the forex market.
The difference between the liquidity inputs of Rs 20,000.18 million received through CBSL’s reverse repo exercise and its subscription of T Bills, versus the output of Rs 2,040 million (repo borrowings) is Rs 17,960.18 million.
On the basis that one $ is equal to Rs 126.30 in interbank spot trading, a sum of Rs 17,960.18 million would be equivalent to $142.2 million, more than the average daily turnover experienced by the forex market, which was the value of the external commitment that GoSL met at Monday’s trading.
According to CBSL statistics, the average daily turnover made by the forex market in the week ended May 17 was a mere $ 47.71 million.
Therefore, GoSL/CBSL in order not to disturb the forex market, procured the necessary forex from CBSL’s external reserves to meet this external commitment, thereby bypassing the forex market.
With reference to the operations of the forex market on Monday, a market source said volumes were thin, and referred to this state of affairs, possibly due to the inclement weather that prevailed on that day.
As a result, the ER in two way quotes in interbank trading was dealing at the Rs 126/25/35 level to the $, the same rate it traded the previous day, he said. One may presume if GoSL procured its $ 142.2 million requirement from the market on Monday, instead of from CBSL’s external reserves, the ER would have had been subjected to a steep depreciation, thereby making the prices of most consumer items to go through the roof, as Sri Lanka is an import dependent economy.
That may be the reason why GoSL refrained from obtaining its forex requirements from the market. But on the flip side, such borrowings, besides causing a liquidity crisis in the economy, also weaken GoSL’s external reserves position.

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