Sri Lanka widens bank dollar trading positions

ECONOMYNEXT - Sri Lanka has widened dollar trading positions of some banks, market participants said, which were recently slashed amid a run on the rupee triggered by a spike in unsterilized excess liquidity.

Cuts in the so-called NOPs (net open positions) have led to heightened volatility of the rupee in the past, according analysts who have closely studied policy errors of the central bank.

A wider NOP allow foreign exchange flows from day-to-day to be matched without altering the monetary base, making Sri Lanka's credit system behave like a floating regime.

A narrower NOP requires greater central bank intervention to keep a currency stable. Intervention by the central bank alters the monetary base, making the exchange regime behave like a peg.

But dollar purchases by the central bank at current rates will inject permanent liquidity, peg the currency and undermine a float.

Though the credit system now has a large liquidity shortage which can absorb some injections, the actual damage of central bank dollar purchases in the market will be done by creating an opinion among exporters an opinion that the current exchange is justified and is not an overshoot.

Analysts have also said that NOPs can be linked to liquidity positions of banks on the basis that banks that borrow printed money from the central bank, should not be entitled to hold dollars with such money.

This will encourage banks to run plus liquidity positions in the long term and not fund credit with window money.

However the current large liquidity shortage is coming from a policy error of the central bank involving a hedging deal on a loan taken by National Savings Bank in 2013.

The monetary policy of the central bank is now supportive of the rupee. Overnight interest rates are near the 8.50 percent ceiling policy rate.

On Wednesday 3-month Treasury bill yields rose sharply to 9.38 percent.

In the past, the central bank has made currency pressure turn into full-blown balance of payments crisis by injecting 3-month printed money at subsidized rates into the banks, by intervening in bill auctions which can be loaned customers to generate more pressure on the rupee.

Analysts say laws should be brought to prohibit the central bank from injecting money below the Sri Lanka Interbank Offered Rate of that tenor to maintain economic stability and preserve the welfare of the people, especially when the rupee is under pressure.

Sri Lanka's rupee is unstable due to the lack of a consistent or market based operating regime, involving targeting either the interest rate (floating rate) or the exchange rate (peg) consistently. (Colombo/Oct11/2018)

Thanks Invinsible.
But hard to digest.
Could anyone explain this in simple terms in therena bashawen.