ECONOMYNEXT – Sri Lanka’s central bank has mopped up 900 billion rupees of liquidity in 2024, operating broadly deflationary policy, building foreign reserves and providing below 2 percent inflation for people to re-build their lives, official data shows.
The central bank has generated 857.8 billion rupees through outright purchases of dollars, creating non-borrowed rupee reserves for banks, according to market operations report for the full year 2024.
It had also created 25.4 billion rupees through forex swaps and 96.9 billion rupees through foreign loan proceeds, creating a total of 980.1 billion rupees of liquidity.
Deflationary Operations
The central bank has terminated 194 billion rupees of term reverse repo, sold 228 billion rupees of bills to mop liquidity.
When the securities go to bank balance sheets, they cannot lend it to the broader economy for clients to invest or spend and generate imports.
There were also 305.8 billion rupees absorbed by the statutory reserve ratio and “other CBSL absorptions, the central bank said.
The central bank said separately that the government had paid in 300.7 billion rupees of interest on its bond holding.
Currency withdrawals were 172.2 billion rupees.
The deflationary operations totaled 900 billion rupees including the currency withdrawal by users of money. Meanwhile the overnight surplus moved up by 80 moved up by to 168.1 billion rupees by end December 2024, data showed.
Inflationary Domestic Operations
However there was a surge of inflationary operations the last quarter of 2024, ahead of a rate cut.
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The central bank injected large volumes of liquidity through its term and overnight facilities starting from around September leading to warnings that it will trigger external instability as it tried push interest rates towards the floor of the corridor.
“Despite improved liquidity conditions, the Central Bank was compelled to intervene regularly in the domestic money market through OMOs due to the continued asymmetry in liquidity distribution among market participants,” the central bank claimed.
“This imbalance was a result of the cautious approach and stringent risk mitigation measures adopted by some Licensed Commercial Banks (LCBs), particularly foreign banks, following Sri Lanka’s sovereign rating downgrade.”
However, analysts had pointed out that the what the central bank was doing was moving to an inflationary abundant reserves regime which undermines the working of the call market, mis-prices risk and encourage banks to lend without deposit.
Banks which were short of liquidity have to reduce trading and credit for a time through prudent asset liability management and not depend on foreign banks or central bank to bail them out for months on end, so they can lend without deposits and trigger holes in the balance of payments, analysts said.
Analysts have warned that similar events had taken place in 2015, 2018 and from late 2019 as private credit recovered, leading to currency depreciation and eventual default.
Sri Lanka’s private credit surged in December to unusual levels and import surged to crisis era levels of 1.9 billion dollars. However excess liquidity had reduced by February.
The central bank had also bought 12 billion in bonds in 2024, the report said. Outright purchases of securities gives banks non-borrowed rupees reserves to lend and generate imports and create external pressure as there are no backing reserves at the central bank to defend the currency.
Analysts have earlier pointed out that the central bank should be controlled by law to a ‘bills only’ policy given the experience since the end of a civil war and had now warned that the single policy rate will take the country closer to a second default.
T-bills expire in three months, in the style of the ‘real bills doctrine’, which can reduce the hit on the balance of payments, though cascading credit can hit the exchange rate earlier.
(Colombo/Feb09/2025)
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