Inconsistent Policies Cause Interest, Exchange Rate Pressure

Market’s illiquid state compounded by seasonal demand for money, coupled with the lack of confidence in the establishment that is also driving demand for US dollars ($s) and rates as well, forced Central Bank of Sri Lanka (CBSL) to hold a reverse repo auction on Friday (December 16) to tide over the situation
Overnight (O/n) call money rates went up to 9¼% before settling down at the 8.75-9% level after Rs. 10 billion was sold to the market at an o/n rate of 7.68% level at this auction, a market source told this reporter. On Thursday two way call money quotes shot up to 8/48/60% levels, where the weighted average rate of call money on Wednesday was 8.28% according to CBSL data, up from the previous day’s 8.23%.
Market liquidity was Rs. 16 billion on Thursday down from the previous Rs. 19 billion, with much of this liquidity however captured by foreign banks which apparently have “stricter” limits when in comes to inter-bank lending
Market figures couldn’t be independently verified because in the past day or two CBSL, despite e.mail reminders has been lax at least to this newspaper in sending out its daily “open market operations” and weekly “government securities market” reports which it commonly used to do in the past, which among other things provide information on call money rates, market’s liquidity status and foreign holdings in government securities, official data that may give a direction as to where market interest rates and the exchange rate are heading.
“The market, after Budget 2012 which was held on November 21 has lost confidence in the establishment due to the contrary stance it has taken in regard to its exchange rate and money market policies,” he said.
President Mahinda Rajapaksa appeared to have had dropped a bombshell when presenting Budget 2012 in Parliament by devaluing the rupee by 3%, with the CBSL, which had hitherto been preventing the exchange rate from rising (by selling $s at below market rates thereby diminishing its foreign exchange (forex) reserves) and also by previously not allowing Treasury (T) Bill yields to rise by either subscribing to the same at administered prices  or getting captive funds such as the EPF to do the same, also abandoned this protection soon afterwards, with the weighted average yields (WAYs) at the weekly T Bill auction that was held two days after the budget, for 91, 182 and 364 day T Bills dramatically going up by 44, 64 and 91 basis points (bps) to 7.95%, 8.18% and 8.50% respectively as a result.
Wednesday’s (December 15) weekly T Bill auction saw the only accepted parcel, ie T Bills of 91 day tenure, too going up by 15 bps to 8.43%, while bids for the other two parcels were rejected. CBSL originally had on offer Rs. 10 billion worth of maturing T Bills for reissue, but ended up offering Rs. 4.746 billion of the same to the market.
Prior to Wednesday’s auction and since the presentation of Budget 2012 in Parliament on November 21, WAYs of T Bills of 91, 182 and 364 day tenures in the three weekly auctions that followed thereafter had had cumulatively gone up by 45, 47 and 147 bps to 8.28%, 8.56% and 9.06% respectively.
The market continued to ask for higher yields for the fourth consecutive week at Wednesday’s T Bill auction as well, resulting in state owned CBSL rejecting bids for the 182 and 364 day tenures while accepting bids only for the 91 day tenure, but at a higher price.
But on Friday where the Indian rupee previously had been on a depreciating trend against the $, however reversed this tide that day by appreciating by two Indian rupees. But pressure for the reverse continued to take place in Sri Lanka.
Higher yields for gilt edged T Bills also have a cascading  effect on market interest rates which then makes borrowings more expensive, stultifying credit growth therewith factory expansion and job creation.
The reason why CBSL accepted bids for the 91 day tenure even though the market asked for higher yields was to meet the short term liquidity crisis driven primarily by seasonal demand, it’s learnt. It’s also alleged that rising credit demand too is driving up yields.
CBSL is expected to offer the amounts for the rejected tenures vide private placements to both administered funds and the market, offering to sell those Bills at the previous week’s tenures. Meanwhile the deepening of scope for foreign investments in Government securities from 10% to 12.5% recently has allegedly pushed up foreign subscriptions in such to 11%, with the full quotient not taken up apparently due to the holiday season.
Latest CBSL data showed that foreign holdings in T Bill outstanding had increased by Rs. 1,270 million to Rs. 74,000 million week on week in the week ended December 14, while foreign holdings in T Bond outstanding stagnated at Rs. 200,390 million.
However a market source alleged that foreigners were in fact planning to withdraw from the government securities market due to the currency depreciation and possibilities of it being devalued further, coupled with rising rates, thereby making it disadvantageous to trade in government securities in the secondary market, though CBSL data released so far didn’t show that that was happening.