The Central Bank of Sri Lanka injected around 100 billion rupees into the banking system by October 25, 2024. This was accomplished through multiple liquidity tools, leading to excess money in the banking system exceeding 190 billion rupee according to Economynext. The excess liquidity deposited in the central bank’s standing facility rose to 193.4 billion rupees by October 25, up from 138 billion rupees a month earlier.

Economynext raised concerns about the Central Bank of Sri Lanka’s monetary policy, arguing that its actions amount to printing money and could lead to negative economic consequences which raised a huge public attention. While the bank claims to have more freedom to manage the money supply under the new Central Bank Act and IMF agreement, critics argue that this freedom has led to excessive liquidity injections and potential manipulation of government securities yields.

The sources highlight that the Central Bank injected a significant amount of rupees into the banking system, leading to excess liquidity. They argue that this injection, achieved through various liquidity tools, is essentially a form of printing money. This practice is criticised as it could lead to forex shortages, monetary instability, social unrest, and even malnutrition, as seen in the past.

The Central Bank of Sri Lanka employs several measures to control the money supply, such as printing money, open market operations (OMO), liquidity tools, reserve requirements, foreign exchange operation, and interest rate management. The current discussion on money printing which was sparked through the said article started mainly with a wrong perception among the public and politicians into believing that the new law prevents the Central Bank from ‘printing money’. This is a false narrative, as the Central Bank retains significant control over the money supply through open market operations and other liquidity tools.

Through open market operations, the Central Bank now has the power to inject unlimited liquidity into the banking system, effectively enabling banks to operate without deposits. A key point of contention is the Central Bank’s use of open market operations (OMO). While the bank claims that OMO is necessary to manage interest rates and inflation, critics argue that it provides the bank with unlimited power to print money and inject liquidity into banks. This, they claim, enables banks to engage in trading without sufficient deposits and could contribute to inflationary pressures and speculative behaviour.

The sources also point to the potential manipulation of government securities yields through excessive liquidity injections. They suggest that the Central Bank might be trying to suppress yields, which would be an indirect way of monetizing deficits. This practice is viewed as concerning because it undermines fiscal discipline and could lead to unsustainable debt levels.

The Economynext website draws parallels with historical examples, such as the Federal Reserve’s actions in the US, to illustrate the potential dangers of unchecked monetary expansion. It highlights how similar policies in the past have led to economic bubbles, inflation, and financial crises. They also criticise the adoption of a 5% inflation target, arguing that it gives the Central Bank too much room to misuse its instrument independence and potentially trigger external shocks and higher interest rates. They contend that focusing on a single policy rate and using OMO to manipulate it could exacerbate these risks and lead to further economic instability.

Under the original Central Bank Act, the central bank had the authority to print money through various means, including purchasing Treasury bills, providing provisional advances to finance the budget, and refinancing credit. However, this authority was constrained by a gold and exchange rate peg, which served as a check on excessive money printing. The new Monetary Law, crafted after the IMF’s second amendment to its articles, eliminated the gold and exchange rate peg, replacing it with a “flexible exchange rate” system. This shift granted the Central Bank significantly more freedom to print money without the previous constraints. The new act also introduced a 5% inflation target.

However, there is another argument that the primary factor used to determine the amount of money to be printed in Sri Lanka is expected economic growth. Economic growth leads to an increase in the number of transactions taking place in the country, which in turn requires a larger money supply. Increasing the money supply through printing is necessary to facilitate this growth and does not necessarily result in inflation.

In addition to economic growth, the desired inflation level also plays a role in determining the amount of money to be printed. The Central Bank of Sri Lanka aims to maintain inflation at 5%. To achieve this target, a certain amount of money printing is required on an ongoing basis. For example, if economic growth is projected at 3%, the money supply would need to increase by around 8% annually to maintain the 5% inflation target.

It is important to note that increasing the money supply in this way refers to a long-term trend. There are daily fluctuations in money demand and supply based on market factors, and the Central Bank adjusts the money supply based on this demand. CBSL prints money as per the set standards in the IMF agreement, which won’t be a concern to the economy until the limitations and guidelines are promptly followed. Having said that, the lack of restraint, if adopted, powered by OMO raises potential concerns of excessive money printing and risks such as inflation, currency depreciation, economic bubbles and financial instability.