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CBSL Buys, Retires T Bills With Vengeance

If Central Bank of Sri Lanka (CBSL) was on a retiring mode of some of its Treasury (T) Bill holdings in the first three days of trading last week in a market cut short by a day due to Wednesday’s December 25 Christmas holiday, then it came back with a vengeance on Friday reversing all of those gains, by increasing its gross T Bill holdings by 427.6% (Rs. 44,841.53 million) to Rs. 55,329.39 million; Friday over Thursday, CBSL data showed.

CBSL, by buying T Bills achieves two things: It meets Government of Sri Lanka’s (GoSL’s) expenditure needs, while at the same time infusing liquidity to the market. However, the danger in supplying liquidity this way is that it may cause demand side inflationary pressure on the economy.

Nevertheless, CBSL in the first three days of trading last week shed its gross T Bill holdings by 77.5% (Rs. 36,024.05 million (ie by retiring T Bills of an equivalent value) to Rs. 10,487.86 million.

When CBSL retires maturing T Bills on that drains out an equivalent amount of liquidity from the market, thereby relieving demand side inflationary pressure to that extent. However, if the market becomes illiquid as a result of such an action, that may cause rates to rise.

A pattern has seemingly emerged, where, especially these days, CBSL buys T Bills towards the end of the week, whilst retiring them during the course of the following week, only to end up re-subscribing to the same by the weekend.

Week on week (WoW) CBSL’s gross T Bill holdings has had increased by 19% (Rs. 8,817.48 million) to Rs. 55,329.39 million as at Friday.
Almost in tandem with CBSL’s Friday’s T Bill buying programme, market’s excess liquidity, Friday over Thursday, increased by 259.9% (Rs. 38,398 million) to Rs. 53,172 million; data showed.

Under perfect conditions, the increase in money market’s excess liquidity should be equivalent to the increase in CBSL’s gross T Bill holdings.

Hiked

But while CBSL’s gross T Bill holdings was hiked by Rs. 44,841.53 million; the increase in market’s excess liquidity lagged behind at Rs. 38,398 million, the difference, ie Rs. 6,443.53 million having had been swallowed up in a possible submarket operation.

This happens when GoSL has to meet an external commitment like foreign debt servicing. In such an instance the required foreign exchange (FX) is not bought from the FX market, but from CBSL’s external reserves.

However, in this exercise the equivalent rupee liquidity is drawn out from the money market to pay CBSL for the required FX. This sort of activity may weaken market’s excess liquidity as well as CBSL’s FX reserves holdings.

The FX market is left out of this equation on the belief that if the required FX was bought from the FX market it would place pressure on the rupee to weaken. Sri Lanka runs a deficit in its current account in the balance of payments.

At the beginning of the week on Monday (December 23), market’s excess liquidity contracted due to CBSL retiring part of its T Bill holdings upon maturity. CBSL retired Rs. 5,579 million (16.6%) of its T Bill holdings to Rs. 27,972.34 million on that day’s trading.

Similarly, market’s excess liquidity over that of the previous day’s figure decreased by Rs. 6,304 million (19%) to Rs. 26,805 million.

Liquidity

The difference, ie the decline in market’s excess liquidity at a faster rate than the retirement value of CBSL’s T Bill holdings, ie by an amount of Rs. 725 million (Rs. 6,304 million-Rs. 5,579 million), as described above, may have had been due to CBSL helping  GoSL to meet an external commitment. Meanwhile market’s excess liquidity, Tuesday over Monday, declined by Rs. 923 million (3.4%) to Rs. 25,882 million. In tandem with these developments, CBSL’s gross T Bill holdings decreased by Rs. 1,360.7 million (4.9%) to Rs. 26,611.64 million.

But the reason why excess liquidity declined by a lesser figure, ie by an amount of Rs. 923 million only, and not by an amount of Rs. 1,360.7 million, may be due to the receipt of inflows.

These days there is pressure for the rupee to appreciate due to remittances. CBSL however is not allowing the rupee to appreciate, by buying these inflows at a depreciated rupee price, thereby strengthening its external reserves position and in the process, flooding the money market with rupees in this exercise.

It may therefore be assumed that the difference, ie Rs. 437.7 million (Rs. 1,360.7 million-Rs. 923 million) was due to CBSL buying an equivalent amount of inflows, and paying the market in rupees in lieu, thereby preventing market’s excess liquidity to decline by an equivalent value to that of retiring T Bills.

Meanwhile , the weighted average rate of call money transactions WoW as at Friday declined by six bps to7.69%, while that of overnight market repurchase transactions increased by  seven bps to 7.09%.

On Thursday, market’s excess liquidity, in tandem with the decline in CBSL’s gross T Bill holdings, also decreased, Thursday (December 26) over Tuesday (December 24), data showed.

CBSL’s gross T Bill holdings declined by Rs. 10,487.86 million (39.4%) to Rs. 16,123.78 million during this short period, while market’s excess liquidity decreased by Rs. 11,108 million (42.9%) to Rs. 14,774 million.

As described aforesaid, the reason why the value in the decline in CBSL’s gross T Bill holdings is not equivalent to the decline in excess liquidity may be due to a submarket operation, where excess liquidity had had diminished at a pace greater by Rs. 620.14 million (Rs. 11,108 million-Rs. 10, 487.86 million) over that of the value of retiring T Bills.

Generally a decline in excess liquidity causes pressure for rates to rise and not the contrary, unless there is slack demand in the money market, like poor credit growth for instance (see also the business pages in last week’s issue of The Sunday Leader).

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