Reflections Of Low Economic Activity

• Excess Liquidity, Small Forex Market

Excess liquidity coupled with low volumes of foreign exchange traded have been continuing to bug markets here, which a source attributed as being are reflection of the low levels of economic activity taking place in the country.
Despite a spike last Friday, the foreign exchange (forex) market has been averaging at between the US$20-30 million turnover levels on a daily basis, while the market has been averaging excess liquidity levels to the tune of Rs. 150 billion, which has moderately come down since, due to seasonal demand coupled with Central Bank of Sri Lanka (CBSL) absorbing some of the excess, he said.
The source further said that with the Government and CBSL giving priority to inflation targeting, and with inflationary pressure building up on the economy, investors are adopting a “wait and see” attitude, looking for direction, in the money market.
The ill effects of inflation are mitigated by a rise in interest rates so as to drain out the excess liquidity in the market in order to maintain price stability.
CBSL has kept its policy rate, the rate at which it pays the market for parking its excess liquidity with it on an overnight basis, unchanged at 7.25% for quite some time, with its monthly review due next month (January).
As a result of this uncertainty, coupled with the advent of the holiday season, the Treasury (T) Bond secondary market has also been dull, he said. Demand has a tendency to bring down rates, while a sluggish money market may activate a rate rise.
For instance the more popular 2015 maturity T Bond has been holding on unchanged at the 9.20/25% levels upto Thursday.
Wednesday’s primary T Bill auction too saw no changes in the rates week on week, ie the 91, 182 and 364 day maturities commanding average yields of 7.25 (same as CBSL’s policy rate), 7.38% and 7.55% respectively, while the yields of the other two “longer” tenures, if prorated, is in tandem with the shorter tenure T Bill.

CBSL is expected to issue some T Bonds of tenures of five years or more to the market next month in order to replace Bonds of such tenures which mature next month. The yields fetched by the new issues at those auctions may give a rate direction, the source said.
Meanwhile the market has been recording excess liquidity at the Rs 150 billion level range during the past few weeks due to slack demand in the real economy. This figure has since come down due to seasonal demand, coupled with CBSL draining out part of the excess. Market excess liquidity on Tuesday was Rs. 118 billion, it went down to Rs. 112 billion on Wednesday, while picking up slightly to Rs.113 biIlion on Thursday.
Continuous excess liquidity in the market is attributed to sluggish economic activity.The settlement of a US$ 50 million wheat import bill by a private party last Friday, coupled with an oil import bill settlement, lifted turnover in the forex market by five fold to the US$ 94 million level, while at the same time causing the rupee to dip by between 20-30 Sri Lanka (SL) cents against the greenback to be quoted at the Rs. 111/15/20 levels in two way quotes that day, with those rates continuing upto Tuesday.
“CBSL didn’t intervene in the market to prevent the rupee dip, now-a-days CBSL’s intervention is confined to preventing the rupee from appreciating,” he said.
A strong rupee hurts exporters because they get fewer rupees for their forex earnings, while conversely a weaker rupee hurts importers because they have to spend more rupees to buy forex to make their import purchases.
Previously, with reserves low, the pressure had been for the rupee to dip due to the high demand for dollars. But now with reserves having had been increased to US$ 6.6 billion, in part caused by the Government being able to clinch a US$ 2.5 billion standby arrangement from the IMF last year, coupled with the attendant confidence that this deal has given money market investors, further buttressed by Sri Lanka’s high interest rate regime, that has brought about foreign inflows into T Bonds and T Bills, giving a boost to the country’s foreign reserves as a result.
“Usually daily turnover in the forex market is in the range of US$ 20-30 million,” the source said. It has not picked-up because the economy has not taken-off, he added.
On Tuesday the rupee continued to hold at the Rs. 111/15/20 levels due to sluggish demand caused by the season’s holidays, with no CBSL intervention, while on Thursday, due to inflows it appreciated to the Rs. 111/10 levels in spot tradiing.

EPF Moves In
EPF moved into the market on Thursday, buying the biggest slice of the 2.5 million JKH shares that were traded.
However, the herd instinct that boosted the market was created by foreign buying into JKH and Commercial Bank the day before, on Wednesday, with the rest of the market following, and EPF’s Thursday’s intervention helping to keep up the moment.
With the year end just five days away, the props, like EPF intervention, are likely to continue in the coming days as well, giving a fillip to inflate valuations (ie in “stock broking accounts”) and create a pretty year end picture for the bourse.
The market in the two days ended Thursday, has seen the benchmark ASPI move up 132.6 points (2.1%) and the more sensitive MPI by 145.3 points (2.1%) to close Thursday at 6,511.51 and 6974.30 respectively.