Sri Lanka could begin balance sheet runoff soon with ending of asset purchases

 Sri Lanka could begin tapering off its nearly Rs.2.0 trillion balance sheet after the rates were hiked and start ending injecting new liquidity through Treasury bills and bonds, as the government is reforming its own finances with a substantial cut in its expenses and the expected increase in taxes under an International Monetary Fund (IMF)-backed programme. 

According to the new Treasury Secretary Mahinda Siriwardena, he would soon issue a circular asking all state agencies to cut their spending.

Meanwhile, the taxes, which were cut drastically in 2019 under a fiscal stimulus programme, would soon be raised to institute revenue-based fiscal consolidation, which is one of the conditions, which will come with a potential IMF rescue package currently under discussion. 

The sharp increase in interest rates on April 8 could also enable the Central Bank to raise money for the government through markets rather than resorting print money.

Higher interest rates increase savings, which could then be used to fund the borrowings required by the government. 

A section of economists deeply believe that the current bout of inflation is a direct result of the unrestrained money printing by the Central Bank from March 2020, when the virus forced Sri Lanka to lockdown its economy for nearly two months, followed by intermittent lockdowns through October 2021, which impaired the country’s economic output. 

By the end of April 19, the Central Bank had Rs.1.87 trillion worth of assets at face value, compared to Rs.78.21 billion on March 1, 2020, just prior to Sri Lanka entering the pandemic. 

The newly-appointed Central Bank Governor Dr. Nandalal Weerasinghe, who was Senior Deputy Governor, at the time said he pointed out the need to slow down the asset buying process when they came to around Rs.300 billion. “But we weren’t trusted,” he said.  

After President Gotabaya Rajapaksa chided the senior Central Bank officials in June that year, the Central Bank doubled down on the pace of asset purchases on behalf of the government and cut rates to historically low levels.  
Dr. Weeraisnghe on April 8 said money printing by itself is not something bad, as a Central Bank must print some amount of money in order to maintain its target inflation trajectory and also to support the banking sector and thereby achieve growth aspirations. 

Sri Lanka from April 06 to April 11 bought assets worth of Rs.122.50 billion, which was used to pay the state sector salaries and their festival advances prior to the New Year. 

Money printing causes inflation when there is no corresponding growth in the productive capacity of the economy in line with the growth in the money. This is precisely the reason for part of the inflation experienced today, as printed money is sent directly to the people, who stayed at home due to lockdowns. 

The other part is the supply-driven inflation, which Sri Lanka has no control over, such as the supply chain bottlenecks caused by the pandemic-induced lockdowns and commodities prices rally since Russia’s invasion of Ukraine. 

There is also a difference between monetary financing and actual money printing, which is done based on the need for the amount of currency in circulation.

Sri Lanka has to earn dollars to spend dollars and no amount of rates—interest rates, foreign exchange rate or tax rates—would enable the Lankans to enjoy foreign made goods and services.