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Home Business & Finance Economic Policies

Sri Lanka excludes excess reserves from monetary base on IMF manual todayheadline

February 5, 2025
in Economic Policies
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ECONOMYNEXT – Sri Lanka’s central bank has excluded excess reserves from the reported monetary base, due to a definition in an International Monetary Fund manual a top official said, amid volatile data published in the run up to and around currency crises.

The monetary base or reserve money, is currency issued by the central bank which is held by the public (notes and coins in circulation) and banks as well as those deposited in the central bank.

These instruments, which are mostly zero-coupon instruments now, are used in final clearing of transactions in a country, and were generally called the circulating medium in classical times.

In some countries, central banks later imposed a statutory reserve requirement or SRR, where banks have to hold a representative part of their deposits within the central bank.

Excess Reserves

In Sri Lanka, cash deposited in the central bank in excess of statutory reserves seems to be excluded from reserve money as seen when the reported reserve money drops precipitously the day after the SRR is cut.

If the money is deposited back in the central bank’s depository facility the commercial bank can also earn interest on those holdings as a ‘remunerated’ excess reserve. In Sri Lanka required reserves are not remunerated.

“One part is currency, the other part is reserves, reserves that we create by the central bank,” the central bank’s head of domestic operations, Anil Perera told reporters.

“So, out of these two, the reserve money is defined, any excess that is created in the banking system, then that can be deposited in the deposit account there.

“So, that is not actually part of reserve money, that is actually excess reserves. So, the definition is very clear in terms of reserves and the currency. I recommend that we refer to the IMF manual, MFSM.”

It is not clear from the IMF’s Monetary and financial statistics manual and compilation guide however that excess reserves are excluded from reserve money.

“The monetary base is defined as currency in circulation, ODCs’ deposit holdings at the central bank, and those deposits of money-holding sectors at the central bank that are also included in broad money,” the manual published in 2017 available on the IMF website says.

Reserve money includes “reserve requirements (including any excess reserves) that are based on averaging of reserve holdings” it says.

“Reserve money also includes reserve requirements (including any excess reserves) that are pre-specified fixed amounts of required reserves (without averaging of reserve holdings).”

The manual says that “transferable deposits” are also included in reserve money.

What if there was no SRR?

The problem of getting embroiled in reserve requirements however is that not all countries have reserve requirements in the first place.

The UK for example only had reserve requirements for a short period in the history of the Bank of England.

The UK briefly had reserve requirements in the great inflation period and ended them in 1981 and there were voluntary reserves till 2009.

Reserve requirements were a tool imposed on national banks in the US (before central banking) in 1863, which however failed to prevent bank runs due to excessive note issue, including against government securities.

The UK before the policy rate, open market operations and permanent inflation, had tight restrictions on the note issue (printing money in layman’s terms) anchored to specie through the Bank Charter Act.

The US no longer has required reserves and all ‘reserve balances’ are included in the monetary base. But reserve balances are now remunerated, through the so-called IORB rate.

Unremunerated Excess Reserves

In Sri Lanka a further complication arose after the central bank decided to unremunerate excess reserves for a period, which led to reported reserve money fluctuating wildly as banks could not longer park cash in the standard deposit facility on some days.

“It is not part of reserve money,” Perera said. “Reserve money is basically defined as the currency in circulation, what is held in their reserves.

“So, on a daily basis, they have the liberty either to park in the reserve account or basically to take it out and use it for their lending purposes.”

Concerns over excess reserves had had tended to rise steeply, when there are short term changes in credit, after the introduction of mid-corridor rate or single policy rate, where large volumes of money is printed (sometimes 10 to 15 percent of the monetary base) to push rates to the floor of a corridor or mid corridor or single rate.
.
Credit Expansion in an Ample Reserve System

The money is then used for credit expansion triggering forex shortages which leads to rupee depreciation under a ‘flexible’ or ‘market determined’ exchange rate, or reserve losses if the new notes are redeemed against foreign reserve sales to stop further expansion of credit.

“The monetary base comprises central bank liabilities that support the expansion of credit and Broad Money,” the IMFs manual itself points out.

Analysts have warned that the single policy rate, which amounts to a floor rate leads to a scrapping of the scarce reserve system that is needed to keep exchange rate stability, and not undermine the workings or mis-price the risks of the interbank money market especially after private credit picks up.

Excess reserves are an automatic symptom of operating a so-called abundant reserve system where large volumes excess money is pumped into the banking system due to external motives which are unrelated to clearing needs of the credit system.

The volumes have sometime been higher than the incremental volumes earlier printed under provisional advances, analysts say.

Under the scarce reserve system used in the past, excess reserves from provisional advances as well as profit transfers were immediately extinguished, reducing their ability to expand credit and hit the balance of payments.

“Countries can have different definitions of the monetary base, depending on their policy and analytical needs. However, it is expected that the components of the monetary base comply with the principles specified in this Manual,” the IMF document says.

“These can be compared with the components presented in Box 6.3 that are consistent with the principles specified in this Manual.”

According to the IMF manual’s Box 6.3, central banks with required reserves, including India and the European Central Banks count excess reserves as reserve money. The complication about ‘excess reserves’ does not arise if there is no statutory reserve requirement.

 

(Colombo/Feb05/2025)

Tags: BaseexcessexcludesIMFLankamanualmonetaryreservesSritodayheadline
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