Money Market, ER Management, Full Marks To CBSL

• During Last Three Months

The exchange rate (ER), as predicted in these columns last week, appeared to have had stabilized at the Rs. 132/30 levels in spot, interbank trading against the US dollar ($), with the first three days of last week seeing the $ being subjected to sales at the Rs. 132/20 levels on Monday and Tuesday and in the following day Wednesday, “going” at Rs. 132/20/30 in two way quotes.*
Volumes however were thin, a market source told this newspaper.
Another source commended Central Bank of Sri Lanka’s (CBSL’s) management of the ER and interest rates in the last three months, helped largely by allowing the rupee to “free” float against the $, whilst resisting pressure to bring rates down by flooding the market with “printed rupees” (see also below).
Meanwhile on Thursday the ER weakened to the Rs. 132/34 levels in spot sales due to state bank buying, probably to settle a Government of Sri Lanka (GoSL) bill, such as that of an import made by state owned Ceylon Petroleum Corporation, with such buying continuing the following day Friday as well, which further weakened the ER to Rs. 132/35/45 levels in two way quotes, another source said.
Import demand is currently exceeding exporters encashing their $ proceeds, he said on Friday. The market is short of $s.
But at the beginning of last week, ie on Monday, the ER on thin volumes strengthened to the Rs. 132.20 level to the $ in interbank spot sales and held on to those levels the following day Tuesday as well,  sources said.
“It’s that exports and imports are matching, in that exporters are encashing their $ proceeds, thereby mitigating any possible pressure on the rupee,” a source had then said. There is no state interference to protect the rupee.
In the last market day of the previous week, ie on August 30, the ER closed at Rs. 132.30 (see also the business pages of this newspaper’s last week’s edition).” It’s nothing much to shout about,” one source said, attributing to the ER’s 10 Sri Lanka cents (SLc) gain; while another said that the reason for its strengthening was because the market was short (ie on Monday).
The market at Monday’s trading was short by Rs. 7,000 million; as the reverse repo auction figures released by CBSL for the day showed. The following day Tuesday market shortfall was Rs. 5,640

million, part of it, ie Rs. 3,500 million, met by CBSL’s reverse repo facility at a 9.65% weighted average yield (WAY), three basis points (bps) higher than the previous day’s 9.62% WAY, while the balance was fed to the market by CBSL’s standby reverse repo facility, ie at the 9.75% rate.
On Wednesday market’s liquidity shortfall further contracted to Rs. 2,920 million, with the possible reason for its reduction being foreign inflows, which may be translated to the market selling $s to CBSL which pays back to the market rupees in return, thereby mitigating the market’s illiquid situation.
Market’s illiquid situation also saw call money transactions’ weighted average rate (WAR) rising, with its WAR on Tuesday increasing by one bp to 10.56% over that of the previous day Monday’s figure, while the WAR of overnight (o/n), gilt edged Treasury (T) Bill backed market repurchase transactions increased even more sharply, by 20 bps to 9.68% on Tuesday**, CBSL data showed.
However the following day Wednesday those call money transactions declined by two bps to 10.54%, while market repo (repurchase) transactions reduced by six bps to 9.62%. There was no reverse repo auction on Wednesday, with the market shortfall met by CBSL’s reverse repo window, at the standard 9.75% rate. On Thursday, the market’s shortfall further contracted to Rs. 232 million, which shortfall was also met by CBSL’s “standard” reverse repo window, ie at the o/n rate of 9.75%.
But at the end of last week, ie on Friday, market’s shortfall rapidly increased to Rs. 984 million.
Despite Thursday’s contraction, call money rates increased by four bps to 10.58% (only to contract to 10.55% on Friday) on the other hand market repurchase transactions fell by one bp to 9.61%, before rising to 9.62% by the weekend.
Market’s illiquid status has a fallout effect on market interest rates, with deposit rates tending to rise in order to attract liquidity, the corresponding effect of which is a rise in lending rates with all the attendant evils that go with thus, such as the possibility of loan default, which may cause a systemic risk to the island’s financial system, coupled with a reining in of investments dampened by high borrowing costs, which in turn may hamper job creation, a harbinger for civil, social and political unrest in Sri Lanka.
“This rupee shortfall in the market compels foreign exchange (forex) holders, generally exporters to encash their $s to meet their rupee requirements, the net effect of which it strengthens the ER,” a source argued. Another however said that exporters were encashing their $ proceeds, a practice they have had been indulging at least for the past few days.
The market being short was attributed to GoSL’s foreign debt servicing, for which purpose it buys $ from CBSL’s forex reserves (rather than from the market, as that would cause pressure on the ER).
After borrowing/buying rupees from the market in lieu (to executed such transactions), that action however drains out rupee liquidity from the market, therewith having a bearing on rates, ie tending rates to rise. Meanwhile another source expected the ER to fluctuate between the Rs. 132.20-132.60 levels in the coming weeks, before Christmas seasonal pressure, taking over the market, which would induce rates to go up, coupled with the natural depreciation of the ER due to demand in the forex market, which, ipso facto will have an impact on the money market as well.
Yet another predicted that Christmas pressure would see the ER depreciate to the Rs. 134 levels, starting with if GoSL’s current buying “spree” of $s “continues” and leading up to Christmas’ seasonal import pressure.
A 4th source said that he expected rates to go up even before seasonal pressure overtakes the market because of CBSL’s huge stock of T Bill holdings, some over Rs. 200 billion (it was Rs. 214.8 billion on Monday and dipped marginally to Rs. 212.6 billion on Tuesday and declined further to Rs. 209.7 billion on Wednesday, to Rs. 205.9 billion on Thursday, before rising to Rs. 207.8 billion on Friday***), that doesn’t give it the manoeuvrability that it might like to have, in order to rein in rates.
“However we shall not see the rapid rise in rates, like some 100 bps or more as we did see in the past, in a period as short as a week when such rapid changes use to take place in the money market then,” he said.
Meanwhile Wednesday’s, weekly T Bill auction saw the WAYs**** of 91, 182 and 364 day tenure T Bills increasing by three and five bps each to 11.44%, 13.12% and 13.16% respectively.
CBSL has been managing the economy quite well in the past three months, the source said, referring to the performances of the forex and money markets during this period.
“But I don’t know what the future portends,” he added.
“However that may be, even during the Christmas season, I don’t expect the ER to depreciate by more than 50 SLc to a rupee,” he said. Considering the development works taking place islandwide, that’s the reason for the market to be short, he said. The source however didn’t describe some development works, such as the Hambantota Port project as white elephants, despite the slowing down in transshipment volumes in Sri Lanka’s flagship Colombo Port due to the global economic crisis, which thereby questions GoSL’s commercial investments on another port, undertaken from one of several commercial loans obtained from China, leaving transparency in such transactions also very much in doubt.
“CBSL’s T Bill holdings has not increased to Rs. 300 billion, nor has the ER slid down to Rs. 140 as the opposition said it would, or T Bill rates increased from 7% to 20%, but rather to only 13%,” he added, giving credit to CBSL for such a performance. Though of course previously, CBSL’s T Bill stock increased from virtually zero to Rs. 200 billion in a short period of a year, he admitted.
The source however said that during the period July of last year to February of this year the economy was handled badly, where CBSL was artificially defending the local currency despite pressure for it to weaken because of market forces.
As a result of that stance, CBSL depleted its foreign exchange (forex) reserves, causing an illiquid situation in the market because of that action, which was however “solved” by CBSL flooding the market with printed money (hence the reason for its high stock of T Bills), but an activity that causes inflationary pressure (ie the increase in prices) on the economy, which hits the poor and the fixed wage earner the hardest.
GoSL corrected this anomaly by first depreciating the rupee by 3% in Budget 2012 last November, followed by the virtual free float of the rupee in February ( it has depreciated by 20% since November), increasing the administered prices of energy, milk food, cement, bread and bus fares, hiking policy rates, upping the import taxes on motor-vehicles, imposing an 18% credit growth ceiling on banks, which however could be increased to 23%, provided that the additional 5% increase is met through foreign borrowings.
However a weak rupee causes imported prices to go up, made worse as the island is an import dependent economy, thereby hitting the poor and the wage earner the hardest. Further, curbs such as in credit dispensation, hurts growth, which in turn stultify factory expansion, production, innovation and employment opportunities.
“However that may be, due to the critical economic situation that the island is facing, that by itself has helped to curb consumer spending power, which may act as a soother to both the money and forex markets,” another source said. So this Christmas season might be dull, he speculated.
“The market is only interested in covering their positions,” a source said. For the moment it is good, but the acid test is whether the much talked of large foreign direct investments (FDI) would flow into the market, another said.
BoI targets a $ two billion FDI figure this year (see The Sunday Leader business pages of 29.7.12.), but FDI during the first half of the year was $ 452 million (The Sunday Leader business pages of 26.8.12.), and if prorated for the full year, it works out to a figure of $ 904 million, a far cry from the $ two billion target envisaged by BoI. A surfeit of $s in the market, among other things helps to relieve stress on the ER, as a weak ER hits the poor the hardest, in an import dependent economy such as that of Sri Lanka’s. $ liquidity in the economy also lessens pressure on the money market, on the” demand and supply” theory. It also helps to import much wanted capital goods which are not manufactured here, to keep the wheels of the economy ticking. A source however said that liquidity, as known in the market previously, was missing now. He further said that CBSL’s restrictions to curb pressure on the ER like cutting down on banks’ net open positions by 2/3rd was constricting the growth of the market.  Another however said that foreign inflows into the stock market have also played a role in soothing pressure on the ER.
* Generally trades on such instances are done at the middle rate, ie at Rs. 132/25 level, one may take it at this occasion.
**On Monday market repurchase transactions WAR contracted sharply by 12 bps to 9.48% over that of the previous day (August 30) close, CBSL data showed.
*** One of the reasons for the fluctuations in CBSL’s T Bill holdings is due to its repo and reverse repo actions. If it lends money to the market through its reverse repo mechanism, then it obtains an equivalent amount of T Bills in lieu from the market as security, which tends to inflate its T Bill holdings. On the other hand if it wipes out excess liquidity from the market through its repo mechanism, which activity then tends to reduce its T Bill holdings also by an equivalent amount as it then has to provide the market, ie an equivalent amount of T Bills as security on an overnight basis.
**** T Bill yields are generally considered benchmark interest rates because market interest rates generally move in tandem with T Bill yields.  GoSL meets its local borrowing needs by issuing/re-issuing (as the case may be) T Bills to the market.