Monetary operations are the money printing operations carried out by the CB on a daily basis in order to keep the inter-bank daily liquidity conditions consistent with the monetary policy decisions.
Monetary policy decisions are made on policy interest rates and other instruments. Such decisions show 2023 as the year of the peak of the supper tight monetary policy cycle as well as a sudden reverse cycle.
Therefore, this short article is presented to shed some light on the nature and outcomes of the CB’s monetary operations during first three quarters (nine months) of 2023. In this period, 14 September is a historic point of the transition of the monetary policy and operations from the 73 year-long Monetary Law Act to a new legislation, Central Bank of Sri Lanka Act enacted as required by the IMF.
The target group of the article is the economists conversant with concepts and practices on the monetary policy. The objective is to make them tend to ask themselves what the real purpose of the monetary policy operations for the economy and people of the country at large is.
The article is presented in two sections, i.e., monetary policy decisions taken in first three quarters of 2023 and highlights of underlying monetary operations and market outcomes.
I. Monetary policy decisions taken in 2023Six major policy decisions have been reported as shown below.
- 07 January 2023 – restricting the access of commercial bank to the CB’s overnight standing financial facilities for each bank:
- Standing deposit facility only up to 5 days a month
- Standing lending facility only up to 90% of the statutory reserve requirement of the bank
- 03 March 2023 – policy interest rates hike by 1% to 15.5% (SDFR) and 16.5% (SLFR)
- 01 June 2023 – policy interest rates cut by 2.5% to 13% and 14%
- 06 July 2023 – policy interest rates cut by 2% to 11% and 12%
- 08 August 2023 – statutory reserve ratio (SRR) cut by 2% to 2% to release nearly Rs. 200 bn of liquid funds to the banking system
- 25 August 2023 – issuance of the monetary order imposing maximum interest rates on bank credit products in order to require banks to reduce interest rates in line with the monetary policy
Accordingly, monetary tightening peak ends on 1 June and now prevails a loose monetary policy cycle since then.
The next monetary policy decision being the first decision to be made by the newly constituted Monetary Policy Board under the provisions of the Central Bank of Sri Lanka Act is due on 5 October 2023. The decision most probably will be a nice story for a further cut of policy interest rates by 2%-3% in consideration of inflation falling towards zero or negative faster than expected and the urgent need to stimulate credit flows now at low inflation/price stability for the fast recovery of the economy from the worst contraction encountered in the history.
II. Monetary operations
Monetary operations are carried out to maintain the inter-bank market liquidity conditions consistent with the monetary policy decisions. The operation instruments are the standing lending facility (SLF), standing deposit facility (SDF), reverse repo auctions (overnight and term basis) and CB’s direct purchase of Treasury bills.
Al these operations will have direct and indirect impact on money printing and inter-bank liquidity conditions.
In general, like in other central banks, the CB has numerical estimates over the aggregate amount of liquidity in the banking sector on a daily basis and the preferred amount of liquidity in line with monetary policy targets. Accordingly, monetary operations are carried out in a manner to fill the liquidity gaps, i.e., money printing (injection) to fill the liquidity deficit and cut the money printing (absorption) to remove the liquidity surplus.
The overriding objective of such monetary operations is to keep the volatility of overnight inter-bank interest rates around the levels preferred by the CB within the policy interest rates corridor (SDFR and SLFR). However, the monetary policy rhetoric on inflation control/price stability, promotion of growth, financial stability, stable exchange rate, etc., everything under the sun, beyond such monetary operations is highly conceptual and controversial.
Therefore, this article only provides highlights of monetary operations and their immediate outcomes on the surrounding money market with the support of suitable graphics.
1. Monetary operation instruments
- Standing Facilities – SDF and SLF operations
From 16 January 2023, the use of standing facilities has collapsed due to restrictions or rationing imposed by the CB (see Chart 1 below). As a result, bank liquidity management through standing facilities has confronted an usual volatility forcing banks to look for other options. On the other hand, policy interest rates corridor-based monetary policy model also has collapsed due to the rationing of these overnight facilities.
- Reverse repo auction/operations
Consequent to CB’s restriction on SLF, the CB had to inject liquidity through regular reverse repo auctions to prevent the rise in inter-bank interest rates. As a result, unlike in the past, the conduct of reverse repo auctions on both overnight basis and term basis have become a regular operation during the reference period.
Accordingly, nearly 168 auctions offered Rs. 9,850 bn and accepted bids of Rs. 7,537 bn (77%) out of total demand for Rs. 9,500 bn.
- Overnight reverse repo auctions became a daily routine with 86 auctions offering Rs. 6,990 bn or 93% of all auctions (see Chart 2 below).
- Average auction amount was Rs. 80 bn with the acceptance rate of 76.7%.
- A fast reduction in overnight reverse repo volumes is seen from the mid-August possibly consequent to significant contraction in bank credit operations.
- The determination of overnight reverse repo auction interest rates is questionable on several grounds (see Chart 3 below). First, reverse repo rates have been lower than SLFR although credit quality is same for both types of lending. Second, reverse repo rates have been mostly lower than overnight call money rates. Therefore, overnight reverse repo rate has been the de facto policy interest rate used by the CB to drive the inter-bank market as the policy rates corridor has collapsed consequent to the rationing of standing facilities.
- 7-day reverse repo auctions also were used frequently to inject short-term funds so that the pressure on overnight inter-banks rates is pushed down (see Chart 4 below).
- Accordingly, 44 auctions offered Rs. 1,605 bn with the acceptance rate of 78.6% (Rs. 1,261 bn).
- The significantly higher demand for 7-day reverse repo funds has been a general feature and, therefore, the CB has misjudged the demand by offering lower amounts.
- Holding 7-day reverse repo rates at the level of SLFR is highly questionable as to why banks were offered funds cheaper than the overnight SLFR by restricting the SLF unnecessarily (see Chart 5 below). However, the last week of September is seen reducing reverse repo rates well below the SLFR, which has no economic rationale.
- It is observed that long-term reverse repo auctions of several tenures from 10 days to 89 days have been conducted in an irregular manner targeting identified dealers. Nearly 32 such long-term auctions have been conducted offering Rs. 1,135 bn and accepting Rs. 821 bn (72%). The basis and levels of determination of reverse repo rates at these auctions are seen highly questionable as to what the monetary policy relevance is.
- CB’s direct purchase of Treasury bills
The customary practice of the CB has been to subscribe to weekly Treasury bill auctions through the post-auction placements in order to control the short-end of the yield curve/yield rates of government securities in line with the monetary policy. In fact, the de facto short-term policy interest rate has been the Treasury bill auction yield. This practice of direct purchase of Treasury bills by the CB is known as the money printing to fund the government or monetary financing. Such money printing also serves as an indirect source to bank liquidity management outside the direct injection of liquidity by the CB.
It is observed the the CB has been managing the monetary system broadly with the holding of government securities in the range of Rs. 2,500 bn and Rs. 2,600 bn on a daily basis during the reference period while several bumps above Rs. 2,500 bn to Rs. 2,800 bn were also reported (see Chart 6 below).
The bump reported on 21 September is specific due to the conversion of outstanding provisional advances made by the CB to the government into government securities under the domestic debt optimization concept. Accordingly, such conversion amounting to Rs. 344.7 bn as at that date has resulted in raising the CB holding of government securities to historic Rs. 1,901 bn (face value).
Overall, the CB’s liquidity injection (net) has declined on overnight basis due to the impact of drastic restrictions/rationing on CB’s standing facilities (see Chart 7 below). However, the liquidity injection on outstanding basis has remained higher than overnight liquidity injection levels due to the cumulative effect of term reverse repo auctions especially introduced to push the inter-bank interest rates arterially down. Therefore, the reduction in liquidity injection by the CB and its high volatility during monetary policy easing cycle is highly questionable.
2. Money market outcomes
- Overnight inter-bank volumes and interest rates
The objective of the CB to restrict standing facilities in mid-January is to activate the inter-bank market funds (overnight call money and overnight repos) and to drive interest rates down without changes in policy interest rates. However, data do not support this monetary policy hypothesis.
- First, inter-bank market volumes have not surged as expected (see Chart 8 below). Instead, market volumes have been highly volatile and remained at lower levels.
- Second, inter-bank overnight rates (call money and repo rates) have been mostly around the SLFR, the upper bound of the policy rates corridor (see Chart 9 below). A downward movement is observed from overnight call money rates only since August after 4.5% cumulative cut in policy rates since June. However, a parallel reduction is not observed from overnight market repo rates.
- The ease of the market liquidity due to a release of Rs. 200 bn from statutory reserves consequent to the SRR cut by 2% in August could be an important factor to push down call money rates. However, there is a market aberration as market repo rates have not declined parallelly.
- Treasury bill auctions and yield rates
The acceptance of bids worth more than offered amounts and rising access to post-auction private placements without bidding risk have been regular features of weekly Treasury bill auctions (see Chart 10 below).
A significant reduction in the offer to Rs. 50 bn is observed from the last auction held on 26 September as there was no rollover of Treasury bills held by the CB consequent to the conversion of the CB’s total Treasury bill portfolio of around Rs. 2,556 bn (face value) into 10 new medium and long-term Treasury bonds (maturing from 15 March 2029 to 15 June 2038) on 21 September. Therefore, the government will have a significant space for fiscal operations through borrowing from Treasury bill market at future auctions.
The market demand has been primarily for 91-D maturity bills, given market uncertainties amid the debt restructuring issues and concerns (see Chart 11 below). The significant volatility across accepted maturities is a grave concern over the market behaviour.
As in the past, the manipulation of yield rates to serve the requirements of the monetary policy, given the limited scope available with policy interest rates-based monetary policy model, continued to be observed during the reference period (see Chart 12 below). Both conduct of auctions and underwiring of auctions by the CB have been instrumental in this manipulation.
Further, the CB’s reluctance to reduce Treasury bill yield rates during the last two months despite the monetary policy thrust on lower interest rates is questionable. Given the significant reduction in the offer at the last auction to Rs. 50 bn as compared to recent auctions of mostly above Rs. 100 bn to Rs. 180 bn, the cut in yield rates is seen too marginal and not commensurate.
However, as the new legislation permits the CB to subscribe to auctions of Treasury bills up to the total outstanding at 10% of Treasury bill borrowing limit within a period of 18 month from 14 September, the CB will continue to use auctions to manipulate short-term market interest rates as usual.
- The short presentation made above shows that the country’s monetary operations during the reference period have been a set of wholesale trades of short-term money by the CB with a set of profit-seeking money dealers.
- Consequent to new central bank legislation effective from 14 September 2023, the new CB is to admit private securities and shadow banks (finance and leasing companies) also into the wholesale fund/monetary trading equation whereas the purchase of government securities is prohibited for the new CB after a period of 18 months from 14 September.
- The monetary order issued on 25 August to prescribe maximum interest rates on bank credit product has now seized to operate as the new central bank legislation on 14 September does not provide for such monetary powers. As such, new CB has to depend on wholesale money trades with the dealers to drive market interest rates.
- As per IMF 1st review released last week, the CB has to implement a roadmap for addressing banking system capital and liquidity shortfalls and improving the bank resolution framework to ensure financial stability, given bankrupt status of the fiscal front. In that context, these monetary operations are only ad-hoc, micro management of bank liquidity conditions and serve no purpose to address the financial system stability issues.
- Therefore, it is in the utmost national interest if economists and national leaders are prepared to question the real purpose of the present mode of monetary operations for the bankrupt economy and people of the country at large in the current context as nobody except wholesale money dealers seems to benefit from such monetary operations despite the fact that money is a highly regulated public good.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)
Former Deputy Governor, Central Bank of Sri Lanka
(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 12 Economics and Banking Books and a large number of articles published.
The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)
Source: Economy Forward