By: Staff Writer

October 31, Colombo (LNW): The Central Bank of Sri Lanka (CBSL) recently issued a clarification regarding its open market operations (OMOs) following reports that it had printed Rs. 100 billion, allegedly to fund government activities.

The CBSL emphasized that these actions are part of standard procedures to manage liquidity and stabilize interest rates, not direct currency printing. These OMOs aim to maintain price stability, manage interest rates, and help the economy function smoothly, rather than financing government deficits directly.

Through open market operations, central banks buy or sell government securities to control money supply and influence interest rates.

 In Sri Lanka’s case, the CBSL injected Rs. 100 billion into the financial system to help banks meet cash flow demands, keep interest rates within set targets, and foster economic stability. This method allows banks to have more liquidity, facilitating loans to businesses and individuals, which can stimulate economic activity.

Given Sri Lanka’s economic challenges—such as high debt, currency depreciation, and inflation—the CBSL’s liquidity injection aims to support recovery.

However, there are potential risks. Increasing the money supply can lead to inflation, especially if goods and services do not keep pace with demand. In Sri Lanka, inflation is a concern due to recent currency depreciation and economic instability.

The CBSL also stated that some of the recent liquidity injections were responses to liquidity shortages arising from not renewing maturing Treasury securities.

This situation parallels U.S. Federal Reserve actions, where repo facilities help manage liquidity while keeping interest rates stable. In Sri Lanka, however, a managed exchange rate adds another layer of complexity. Increased liquidity can pressure foreign exchange reserves, particularly if private sector borrowing rises.

Historically, the U.S. Federal Reserve’s open market purchases contributed to economic booms and subsequent downturns, including the Great Depression.

In Sri Lanka, there is growing recognition of the potential risks associated with primary market purchases of Treasury securities and provisional advances, which inject new money directly into state banks. This practice boosts rupee reserves, which may end up as private loans, thus affecting the overall money supply.

In Sri Lanka’s open market purchases, funds flow directly to private or state banks, which can then lend to customers, supporting economic activity. However, if the central bank purchases maturing bills, the money either goes to banks or to the former holders of the bills, ultimately increasing money circulation.

The practice of providing provisional advances—funds meant to be repaid but often extended—has similarities with term reverse repos or overnight operations. The new funds eventually reach private borrowers, potentially straining the balance of payments.

Public concerns about the CBSL’s operations reflect misunderstandings around the central bank’s independence. While the CBSL operates independently of the government, its status as a state entity leads many to associate its actions with political leadership. This dynamic has sparked debate over monetary policies and the role of government in financial regulation.

By clarifying its role in OMOs, the CBSL aims to address the misconceptions surrounding its liquidity injections, ensuring that the public understands these actions as standard policy tools rather than direct financial support for government spending. The debate underscores the broader challenges Sri Lanka faces as it navigates economic recovery and stability.