Sri Lanka Treasuries auction fails two weeks in a row

ECONOMYNEXT - Sri Lanka rejected all bids at a Treasuries auction last Wednesday, where an estimated 27 billion rupees of bills were maturing, making it the second week running that auctions failed.

All bids at the auction were also rejected last week where about 26 billion rupees of bills were maturing.

Excess liquidity in money markets went up to 21 billion rupees last Friday turning around from a 10 billion rupee cash shortage after money printed to repay bills hit the market.

On the same day a tranche of Sri Lanka Development Bonds were settled and some of the liquidity appeared to have been mopped up (or maturing bills repaid with proceeds of the dollar bond).

Last week foreign investors also exited from about 20 billion rupees of bonds.

On March 15, excess liquidity in money markets dropped to 10 billion rupees from 26 billion rupees, indicative of heavy reserve outflows.

As long as real bids for bills are rejected and they are repaid with printed money, excess credit and imports will continue to pressure the rupee.

This week an estimated 27 billion rupees of bills are due to mature, though a part of the stock may be already owned by the central bank.

If all the bills are repaid with printed money, the central bank will lose about 180 million dollars in reserves when they turn into bank credit and imports.

Rejecting Treasuries auctions and monetizing the debt (purchasing them into the central bank’s balance sheet) is how the monetary authority generated balance of payments crises and busted the rupee from 1951.

The central bank is effectively avoiding sovereign default of the government of Sri Lanka by printing money to repay bills.

The central bank rejects bids and then when the situation gets tighter sells bills to the public at higher rates.

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 the 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 had delivered a lecture at Institute of Chartered Accounts at Longdon Place during a visit to Sri Lanka.

"..[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," he had said.

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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