Forex foxed?

The country’s forex market encompassing highly dependent importers and key source exporters was yesterday rocked by what analysts described as the sharpest day gain in the US dollar exchange rate.

Before mid-day the Rupee touched a new low of Rs. 127 and then on to Rs. 128 prompting many to assume the rate had bottomed out. However as panic spread within markets, the rate touched a record low of Rs. 131 dealers told the Daily FT.
The change of Rs. 6 or near 5% within a day was claimed as ‘extremely volatile.”
Last Friday the exchange rate was around Rs. 125. Since February, the rupee has seen a 15% devaluation.
The spike yesterday was despite repetitive assurance from Central Bank Governor Nivard Cabraal late last week that Rupee would and is getting stronger.
His confidence however stemmed from the estimation that at least $ 365 million of inflows are expected by end of this month, which is next week.

As reported in the Daily FT yesterday, Cabraal said: “We see the recovery as substantial. All these fellows buying 125 rupees for a dollar will be quite sad finally when they see what is happening.”
He apparent cynicism came after the Central Bank managed Rs. 1 trillion-asset rich Employees Provident Fund (EPF) racked in Rs. 13.7 billion in foreign portfolio inflow on Friday by selling 8.4% stake in premier blue chip JKH to Malaysia’s sovereign wealth fund Khazanah.  Without being specific Cabraal also told Reuters that inflows are expected via investments in to hotel projects, banks raising foreign capital and to the share market. Lower imports were another cushioning factor for expected ease in pressure on the rupee.
However what happened yesterday would have been a rude shaking for Central Bank Chief. Analysts said that the inflows that Cabraal was talking about doesn’t come direct to the inter-bank market instead is retained with the monetary authority. Unless there is fresh infusion from exporters in the short-term, uncertainty will remain.
Dealers told the Daily FT that the forex crisis yesterday reached a level where in the spot market, the usually most liquid in a tighter environment, didn’t have quotes.
Analysts have pinned the blame of the crisis to multiple reasons. One was the recent Central Bank move of drastically cutting as much as 60 to 65% the commercial banks Net Open Positions (NOP), a leeway based on which banks can either keep or oversell dollars. This in turn has made even securing a small contract worth half a million or one million dollars tougher as banks resort to further cover. Inter-bank bid offer spread have ballooned as well as opposed to previous case of narrow spread boosting liquidity.
“At Rs. 131 there were many desperate buyers but no sellers,” a dealer said suggesting the latter’s expectation of further spikes on Tuesday.
Yesterday’s volatility also came midst Central Bank successfully concluding an enhanced Sri Lanka Development Bonds (SLDBs) issue of $ 84 million. (See box story).
Since it is to set off maturing SLDBs, yet again the inter-bank market won’t feel a major boost.
Some however partly attributed yesterday’s spike to the very SLDB issue as it had mopped remaining liquidity in the market as well as fuelling speculation based on at what cost will SLDBs will be raised. Others said that wasn’t the case as $ 84 million was a drop in the ocean.
Analysts also said despite recent policy measures import demand for dollars remains robust, especially eying the April Avurudu season.  That apart some of the restrictive measures along with perhaps excessive speculation have constrained the forex market as well.
“The cycle appears vicious and volatility has made things worse,” analysts said adding that the bottom line was “supply is not sufficient enough to meet the demand.” The volatility in oil prices is a big threat to stability with some claiming unless aggressive conservation measures in place, demand and import cost despite upward price revisions, will rise.
“Exporters are happily keeping their dollars and awaiting to convert later when it further depreciates,” a currency dealer had told Reuters on condition of anonymity. Reuters which reported the rupee hitting the lowest of Rs. 131.60 before closing 130/131also said analysts expect the rupee to recover in April on declining dollar demand and expected exporter conversions.
However the development yesterday also exposes the fact that close scrutiny by the Central Bank even to the extent of visiting banks or raising questions about ordinary transactions have eroded market confidence.
Unlike in recent past, the market didn’t see intervention by the Central Bank via state banks yesterday. This may have given extra room for rupee to dip further as well as fuel speculation.
Central Bank via its previous announcements had expressed its intention to limit its intervention and rely more on demand and supply for the exchange rate to find its equilibrium, which appears elusive as of yesterday.
In its February 15 statement the Central Bank said: “the Central Bank decided to limit its intervention in the forex market, so as to limit the supply of foreign exchange to the extent needed to settle the bulk of petroleum import bills, and to absorb surplus forex liquidity that would flow into the market from various sources including the issue of Tier-2 capital by banks, inflows to equity and bond markets etc., that may otherwise lead to the undue appreciation of the rupee.”
That statement came after a bit of sharp volatility and CB assured that recent measures and actions (such as upward revision in fuel prices and policy rates as well as caps on domestically financed lending among others) would lead to a comfortable Balance of Payments in 2012 and such a surplus would serve to ease any pressure on the forex market.
“In that context, the recent depreciation of the Sri Lanka Rupee, which seems to be a reaction of forex dealers adjusting to the more vibrant market driven policy framework, would appear to be a temporary overshooting of the realistic level,” the CB said in mid February. Judging by the position it took a month ago, the overshooting has aggravated and certainly not a temporary phenomenon.
Apart from $ 120 million inflow via equity market on Friday, a further $ 16 million came in yesterday as EPF sold its Aitken Spence stake to a foreign fund. Central Bank Governor also said both Commercial Bank of Ceylon and Sampath Bank are expected to bring in a total of around $125 million for capital requirements, while a Middle East bank will invest $50 million in treasury securities. Another $75 million for land acquisition by an Indian firm for a hotel project are also expected.
“All this money will come within two to three days,” he said.
 “We know inside out and we know what is coming. Sometimes it may be two or three days later. We have cautioned the market and told them that the inflows will come in and the rupee will stabilise,” Cabraal said in his comments to Reuters on Friday.