Central Bank has acquired 875 million US dollars from a large US fund in an offbeat deal effectively by-passing the domestic money system that boosts forex reserves without creating domestic inflationary or exchange rate pressure.

But the by-pass also meant that the money is not available for Sri Lanka’s cash-strapped finance ministry which has posted record deficits in the current account of the national budget never seen in the island’s history.

From September 2008 to April 2009 Sri Lanka’s central bank bought more than 200 billion rupees worth Treasury bills to pump new money into the monetary system to offset a capital flight, triggering a balance of payments crisis in the process.

"The money has already been used," said Central Bank governor Nivard Cabraal.

"What will happen is that our Treasury bill portfolio will reduce and longer term bonds will be issued to the investor."

Following a float of the rupee in March which ended the balance of payments crisis the Central Bank has steadily sold down its Treasury bill stock, to ‘sterilize’ or withdraw rupees generated from forex purchases.

The bill stock which peaked at over 220 billion rupees in April has since come down to about 160 billion rupees.

Ordinarily, a foreign investor buying a bill from a domestic player - including the Treasury - would see the local party getting the right to spend the money.

But this time, a paper transaction would see the Central Bank getting the dollars, and existing T-bills being effectively converted to a longer instrument, and passed on to the foreign investors.

"This will increase the maturity profile of government debt," Cabraal said.

The transaction is somewhat similar to an International Monetary Fund deal with a central bank. IMF money also cannot be used in the domestic economy, and has no impact on inflation or the exchange rate.

The money is usually re-invested in US government securities if the peg is with the US dollar. But since IMF money is usually cheaper than the US medium term gilt rate, the recipient country can make a profit on the deal.

Though the 875 million dollar deal created no upward pressure on the exchange rate, the rupee was re-pegged about 10 cents up this week, from the earlier 114.90/95 level.

Sri Lanka’s central bank as ‘banker to government’ also settles foreign government loans, without causing pressure on the rupee, through a somewhat similar process.

The proceeds of the inflow, which Governor Cabraal said came from a US based fund, is going to 4 and 6 years government bonds.

Sri Lanka’s 4-year government bond maturing in 01.02.13 was quoted around 12.84/86 percent Thursday, and 6-year 15.03.15 bond was quoted around 12.90/95 percent.

In the US, 5-year bonds now trade at around 2.7 percent, indicating that the negative carry on the deal for Sri Lanka would be about 10.0 percent a year.