Wednesday, February 24, 2016

Sri Lanka Treasuries auction fails despite rate hike

ECONOMYNEXT - Sri Lanka failed to sell the 22 billion rupees of maturing Treasury bills offered for auction on Wednesday selling only 9.2 billion rupees of paper, data from the debt office showed, raising fears that at least a part of the balance will be repaid with printed money.

There is an estimated 26 billion rupees of maturing bills due on Friday.

The debt office, which is a unit of the Central Bank said 6.8 billion rupees of 6-month bills were sold at 8.07 percent, up exactly 50 basis points and 2.3 billion rupees of 12-month bills were sold 8.50 percent, up 55 basis points.

Unlike in the 1990s the Central Bank no longer reveals the volume of money printed each week and market participants have to wait till Friday to find how much freshly minted liquidity hits the interbank market.

The Treasuries auction also failed last week with the central bank's Treasuries stock climbing from around 163 billion rupees to 184 billion rupees and excess liquidity went up from 14 billion rupees to 36 billion rupees.

Analysts warn that despite a 50 basis point rate hike, the monetary authority's habit of using central bank credit to finance the deficit will lead to continued pressure on the currency, as the newly created money generates imports.

The central bank is effectively printing money to prevent sovereign default. From time to time, there has also been foreign bond sales, which generates outflows, which are not directly related to domestic credit conditions.

When the early balance of payments crises started after the central bank was created with money printing powers in 1951, reports show that parliament's Public Accounts Committee had questioned officials closely though the knowledge seems to have been lost later.

The central bank was "forced by necessity" to be main subscriber of Treasury Bills, against its own advice to avoid the government defaulting on its payments, then Governor R W Rajapathirana was quoted as telling the Public Accounts Committee in a 1962 media report reproduced in Central Bank of Sri Lanka in Retrospect published in 2010.

Asked why he could not refuse to buy Treasury bills Governor Rajapathirana had said: "..suppose we refuse to buy and there are no other purchasers then the government has no money to pay its bills. That would be a more chaotic situation than the Central Bank buying Treasury bills."

PAC chairman R S V Poulier: Is it then correct to say that although the Monetary Board functioning in the proper capacity could not recommend the purchase of Treasury bills they had to do it because of the practical necessities?

Governor R W Rajapathirana: That is correct…

In 1968, during another period of balance of payment troubles, John Exter founder Governor of the Central Bank in a lecture at Institute of Chartered Accounts at Longdon Place had said:

"..[A] central bank should show restraint in its monetary policies, there should be a reasonable expansion of credit in the economy but the creation of excess credit by deficit financing were bound to cause inflation, balance of payments difficulties and generally unstable conditions."

Exter had pointed to Singapore and Hong Kong which had no exchange or trade controls and inflation was low.

"The thing about Hong Kong and Singapore was there were no Central Bank-like institutions…" he had said.

Monetary policy was determined by market conditions and were "no organization to disturb the stable dynamism of the economy."

Exter had slammed "The New Economics" of the then US administration, saying the edifice "could collapse like a pack of cards," and the consequences would be "disastrous for the world economy."

His prophesy came true when in 1971 the Bretton Woods system of soft-pegs collapsed ignominiously with gold and oil prices shooting up.

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