Excess liquidity in the banking system continues to plague the island economy as cash balances exceeded cash reserve requirements of banks by a little over Rs 8 billion, against Rs 3.4 billion in January 2013.

To indicate the gravity of the situation, a statement issued by the Bank of Mauritius (BOM) late Thursday afternoon confirms that it has had to resort to an emergency and short-term reverse repo transaction of Rs 1 billion to drain out some of this excess liquidity from the banking system.

Data released by the Central Bank on Thursday showed that all banks taken together held cash balances of Rs 32.39 billion against requirement of Rs 24.31 billion under the Cash Reserve Ratio (CRR), indicating excess liquidity slightly in excess of Rs 8 billion as on January 9, 2014.

It may be noted that the CRR is a ratio which a bank has to maintain with itself in the form of cash reserves or by way of current account with the Central Bank, to be able to meet deposit withdrawals by customers. In the case of Mauritius, the BOM has fixed the CRR at 8%, raising it from 7% last October, citing excess liquidity in the banking system.

Excess liquidity can destablize an economy as it implies that there is too much capital looking for too few investments, or too much money chasing too few goods. This can lead to inflation, and erode the purchasing power of consumers.

In its worst form, excess liquidity can turn into a liquidity glut where capital, for lack of worthwhile investments, becomes invested in bad projects. As ventures go defunct and fail to pay out promised returns, investors are left holding worthless assets.

To prevent such adverse situations from arising in the island economy, BOM, together with the Finance Ministry, is targeting to mop up the excess liquidity by issuing Treasury Notes and government bonds aggregating Rs 34.9 billion to the public in 2014.

It may be noted that the program does not cover treasury bills (essentially short-term bonds that mature within one year or less), which will continue to be issued as and when required, as a short-term intervention.

Under this program, BOM has already released a communique alerting the public of the issuance of three-term Treasury Notes for an amount of Rs 15.9 billion, five-year government bonds for an aggregate nominal amount of Rs 11 billion as well as long-term government bonds (in excess of 10 years) for an aggregate nominal amount of Rs 8 billion. All the above will be sold through auctions on a monthly basis.

In January, staring today, BOM will issue Treasury Notes for three years amounting to Rs 1.4 billion, and on Wednesday, 10-year government bonds will be issued for another Rs 1.4 billion. For the latter, interest will be payable semi-annually, or 24 July and 24 January each year, while the bonds will mature in January 2024.

Earlier, in its latest annual report, the central bank had stated that the series of Bank of Mauritius securities of one-year, three-year and five-year maturity periods seek to “mop up the excess liquidity in the banking system”.

It may be noted that in 2012-13, Bank of Mauritius securities were issued for a whopping Rs 17.3 billion, against a mere Rs 4.4 billion in 2011-12, pointing to the dire need to absorb excess liquidity from the money market.

Caption: Excess liquidity can destablize an economy by leading to inflation, as it implies that too much money is chasing too few goods.