CBSL Rekindles War Memories

• Resumes Reverse Repo Auctions

A liquidity crisis in the market forced Central Bank of Sri Lanka (CBSL) to reintroduce the reverse repo auction at Wednesday’s trading, an action which it last resorted to when the war was on; two years ago.
The auction was repeated in the last two working days of last week as well, with the weighted average yield (WAY) on Thursday falling sharply by 99 basis points (bps) to 7.26% over that of the previous, which a source attributed to “CBSL’s way of controlling rates.”
Higher yields have a cascading effect on market rates, a situation which the Government of Sri Lanka (GoSL)/CBSL is averse to having. It fell by a marginal 1 bp on Friday.
“Some banks are facing a liquidity crunch, that’s what’s made CBSL to revert to the overnight reverse repo auction which they suspended two years ago after market liquidity reached sustainable levels then due to inflows coinciding with the war end,” he said.
However the present scenario has arisen due to CBSL’s defence of the local rupee, the source said. Available statistics show that CBSL has dished out a total of US$ ($) 615 million from its foreign exchange reserves in the months of July and August alone to protect the exchange rate (ER) from falling below various rates decided to by CBSL from time to time.
When CBSL sells $s to the primary market (banks), it buys rupees in return, thereby causing a strain in rupee liquidity in the market, as the rupees meant for the market are instead being absorbed by CBSL, hence, upward pressure on rates due to the limited liquidity available.
Currently CBSL in inter-bank trading is defending the ER at Rs. 110/20 to the $. At present, the scramble for $s is caused due to seasonal demand.
A weak rupee makes imports more expensive and Sri Lanka is an import dependent economy, a possible scenario which GoSL/CBSL wants to avoid.
On the other hand a “strong” rupee (either due to the appreciation of the local currency because of inflows or by artificially protecting it from being depreciated) is detrimental to exporters as they get less rupees for their $s.
Meanwhile call money or inter-bank rates which on Thursday shot up to 8.50% (over the 8.46% level of the previous day Wednesday), subsided to the 8.25% level after Thursday’s auction, the source said. Subsequently call money rates on Thursday closed at an average of 8.39%, seven basis points (bps) less than Wednesday’s close and fell further by 31 bps to 8.08% on Friday.
CBSL on Thursday sold Rs. 7,290 million from its o/n reverse repo window at a WAY of 7.26%, while absorbing excess liquidity totalling Rs. 34,453 million from its standing facility of 7% from the market. Its reverse repo window however saw less activity the following day Friday, selling a mere Rs. 1.3 billion at a 7.25% overnight (o/n)  interest rate to meet market shortfall.
Foreign banks have excess liquidity and the local banks borrow from them to meet their shortfall; however when a “limit” problem arises the local banks then go to CBSL’s reverse repo window to meet that shortfall, the source said.
CBSL on Wednesday offered Rs. 15 billion to the market of which Rs. 1.25 billion was sold at the 8.25% rate, 25 bps less than CBSL’s o/n reverse repo rate of 8.50%  and 21 bps less than the day’s call money rate of 8.46%.
Average call money rates since the beginning of this week rose by a hefty 42 bps to 8.46% by Wednesday, before falling by seven bps by Thursday, and by a further 31 bps to 8.08% on Friday, after CBSL resumed its reverse repo auctions.
A liquidity shortfall would result in rates going up;  a situation which GoSL would not want to happen as that would be a stumbling block to credit growth which in turn may hurt investments and therewith job growth.
As reported in the “Economy” page of this newspaper in its last week’s edition, which, quoting a market source said, “that the year began with the $ at the Rs. 110/80-111 level, so there is no reason why it should not be allowed to appreciate to the Rs. 111/50 level by the year end.
Historically the ER has been depreciating against the $, with the trend being reversed only in the last two years; but now with inflows drying up, I see no reason why CBSL is not allowing the ER to dip, but is instead continuing to protect it..”
During the previous week-end the Indian (I) rupee dipped by more than 50 I cents, from IRs. 48.90 to IRs. 49.45 to the $; the Euro from $ 1.36 to 1.33 and the Great Britain Pound from $ 1.562 to 1.55, he said.
But CBSL continues to defend the ER at Rs. 110/20 to the $ despite the greenback appreciating against all other major currencies, the source said.
“Elsewhere the $ is appreciating, only here it’s being controlled, CBSL Governor only knows where the ER is heading for,” he said.
The source further said that the marginal appreciation ( by two Sri Lanka cents) that the Sri Lanka rupee experienced last Friday (September 30) was due to an Indian bank disgorging $s to the market, an action which took place last Thursday and Friday.
Meanwhile pressure on rates had a bearing at Wednesday’s Treasury (T) Bill (type of Government debt) primary auction which saw the 91, 182 and 364 day maturity T Bills rising by six, four and three bps each to 7.21%, 7.27% and 7.34% respectively at that auction. Further, the yield on the more liquid 2015 maturing T Bonds in secondary market trading rose by 20 bps to 8.90% at Wednesday’s trading, he said.
The source further said that with liquidity fast dissipating, that has had an impact on overnight call money rates, with the same appreciating.
In other developments, last Friday’s (September 30) CBSL’s o/n repo auction saw only Rs. nine billion being parked in CBSL’s repo window at the 7.08% interest rate offered then, whereas the standing facility absorbed nearly twice that amount, a sum of Rs. 17 billion at the lower 7% interest rate.
The source attributed this distortion to the market wanting a higher rate than the 7.08% offered by CBSL that day, but ultimately being compelled to settle for the low standing facility rate of 7% after CBSL in the repo auction rejected those higher bids.

Foreign Investments
Foreign holdings in Treasury (T) Bills and Bonds increased week on week in the week ended Wednesday, Central Bank of Sri Lanka (CBSL) data showed.
While foreign holdings in T Bills increased by Rs. 90 million to Rs. 67,580 million, that on T Bonds increased by Rs. 290 million to Rs. 198,740 million.
Foreign investments in government securities take place when yields offered are attractive. Recently there has been a spike in rates due to the market suffering from a liquidity crisis which has forced CBSL to re-open its reverse repo window to meet this situation.
Capital inflows also help reduce stress on the exchange rate.