Central Bank to begin balance sheet run-off, end new monetary financing

The Central Bank announced this week the initiation of a balance sheet run-off. This move comes as the institution addresses the unprecedentedly substantial expansion of its balance sheet in the recent past.

While the Central Bank would end its monetary financing, or the money printing as referred to in common parlance, it would also start gradually unwinding its outstanding bills and bonds stock held in its balance sheet, perhaps causing some tightening in the monetary conditions.

“The cessation of monetary financing under the CBA, the anchoring of inflation expectations, and the reduction of risk premium on government securities are expected to have a favourable impact over the medium term on the transmission of monetary policy actions by the Central Bank”, the financial sector regulator said in its latest annual policy statement.

The Central Bank emphasised that in the upcoming period, there will be a reduction of the outstanding stock of monetary financing. This process will be executed in accordance with the provisions outlined in the Central Bank Act through the implementation of monetary policy measures.

From the onset of the pandemic in 2020, the Central Bank started providing an unprecedented level of support to the economy by way of Central Bank liquidity which is created by way of purchasing the treasury bills and bonds issued by the government.

While the practice wasn’t anything different from what any Central Bank in the world did during the pandemic by providing liquidity to the markets and also supporting hundreds of thousands of individuals and businesses to backstop them from defaulting and running out of money, some started calling this out as the root cause for the bout of runaway inflation caused during 2022 and part of 2023.

The sell-down or the unwinding of this stock might cause the opposite effect to the current easing policy stance by tightening financial conditions, somewhat offsetting the effects of the easing monetary policy.

The Central Bank had Rs.78.21 billion worth of assets at its face value on March 1, 2020, when the country entered into pandemic-induced shut-downs and broad-based disruptions to the economy for nearly two years.
This has expanded to Rs.2,753.62 billion, although the Central Bank has been practicing much restraint on any more asset purchases since April 2022.

All these assets however do not end up as currency or printed money.

Even according to the programme targets set by the International Monetary Fund (IMF), the Central Bank could not carry over Rs.2.8 trillion worth of assets in its balance sheet. This has necessitated the unwinding of the balance sheet by the Central Bank while requiring the Treasury to maintain a cash buffer to prevent the need for monetary financing.