Manipulated Money Market: Possible Means and Risks - Let us investigate

 


The objective of this short article is to highlight money market manipulations effected by the new OMO/monetary policy rule announced by the Central Bank of Sri Lanka (CB) on 2 January 2023 (see the OMO circular below), effective from 16 January.

Subject Background

I analyzed this subject in my two previous articles (7 and 16 January) as follows.

  • The new OMO rule is nothing but monetary rationing connected with policy interest rates (price controls). Therefore, the general experience that price controls and rationing cause market manipulations by both the state authority and market participants is common to the money market too.

  • The CB would manipulate reverse repo (new liquidity injection) auctions to drive the money market to show expected outcomes mainly through its favored dealers. 

  • The key market outcomes as sated in the CB press release on 7 January are to reactivate the call money and repo markets through market funds and to moderate interest rates structure from present sugar high levels.  

Market Manipulations from 4 to 20 January

Money market data show a clear attempt of the CB to show good outcomes through several market manipulations as follows.
  • The CB has injected Rs. 402.4 bn outside the standing lending facility to increase the market liquidity (see Table 1 below). This is only 70% of needs or bids of the market and 85% of the total auctioned amount. Nearly 90% of new injection is term-reverse repos ranging from 10 days to 89 days.

  • Two overnight reverse repos for Rs. 40.5 bn are no different from standing lending, but used to reduce standing lending in figures. Each overnight reverse repo has been offered to a single dealer.

  • Rs. 60 bn of reverse repo auction held on 12 January for 89 days has been offered to a single dealer at a yield of 27%, cheaper than all shorter-term auctions conducted prior to that.

  • Yield rates given to some identified dealers seem to be highly favourable. For example, the very high yield range on last auction (19 January) at 15.75% and 26% is not justifiable. Therefore, some dealers have got a yield of 15.75%, very cheaper as compared to other dealers who got yields around 26%.

  • The new liquidity injected to selected dealers has led to number crunching. The overnight liquidity improved to a positive position on four days (see Table 2 and C1 below) for the first first time after about 500 days (from 27 August 2021, last day of positive liquidity). 

  • However, the outstanding liquidity deficit remains sugar high due to the injection of new long-term funds to cover up the dampening effects of the standing lending limit. In fact, the deficit rose passing Rs. 550 bn for two days.

  • The sudden reduction of the standing deposits to Rs. 27-29 bn on 18 and 19 January and rise back to around normal levels above Rs. 300 bn last Friday seem to be a clear manipulation. The extent of the reduction does not support the new money market activity (call and repo) around Rs. 10-12 bn from the effective date of the new OMO rule. 

  • A significant reduction in standing lending from above Rs. 500 bn to Rs. 197 bn has commenced well before the effective date of the new OMO rule. However, the money market has received long-term funds around Rs. 360 bn from CB auctions to cover up the forced reduction in standing lending to Rs. 179 bn by Friday. This has caused financial losses to market participants through higher interest rates paid due to the forced curtailment of the standing lending available at 15.5%.

  • Therefore, new OMO operations have shocked the market and caused an alarming volatility in both volumes and rates (see table 2, C1 and C2). The sudden decline in the market repo rate to 15.22% for a lower volume on 17 January below 15.5%, upper limit of the call rate corridor, is not justifiable.

Overall Observations

  • OMO data of last two weeks shows several CB-induced market manipulations through,

        1. Offering favourable deals to identified dealers at a loss to public funds.

        2. Crunching numbers to show the reactivated money market and rate                    reductions through injection of term funds.

  • The OMO has led to a shocking volatility and uncertainty in the money market. This kind of micro and ad-hoc OMO could trigger systemic risks in the near-term, given the significant illiquidity and insolvency confronted by the financial system and the government as a result of the current economic crisis and red hot monetary policy. The CB economists must be aware of dangers of macroprudential risks built-up across the economy at such times although they have no idea of trigger points in the fundamentally flawed monetary system built on short-term liabilities.

  • Consequent to the nee OMO rule of the Director, Domestic Operations, and the related press release dated 7 January, the Monetary Board has now lost its overnight inter-bank interest rates corridor-based monetary policy adopted for inflation targeting. Therefore, the Monetary Board is in gross violation of its public duties under the Monetary Law Act.

  • Therefore, such policy manipulations and violations call for forensic investigations by relevant authorities such as the Minister of Finance and Auditor General, given heightened public concerns raised over state irregularities and bankruptcies.

  • Such investigations are necessary to improve the monetary policy governance and discipline at the CB because monetary policies around the world are conducted in an orderly manner for the objective of controlling inflation through transparent interest rate targets and OMO as disclosed in the monetary policy press releases and press conferences. The CB's claim for the new OMO rule to help restore the stability of the economy while preserving the financial system stability at this stage has no justification.














(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.)


P Samarasiri

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 10 Economics and Banking Books and a large number of articles publish. 

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)

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