Stage Set For FDI Inflows

• Rupee, Interest Rate Stability, Reasons

The exchange rate (ER) and the interest rate are stable, making it conducive for the economy to attract foreign direct investments (FDIs), a source told this newspaper on Monday (September 24).
The ER which strengthened from Rs. 132 to Rs. 131 to the US dollar ($) in a week in interbank spot trading strengthened further by Rs. Two to Rs. 129 at Thursday’s trading (see also box article on this  page).
Volumes were relatively huge on Thursday, between the range of Rs. 70-80 million, another source said.“The market has come to terms that the ER volatility is a thing of the past, but I don’t think the ER will strengthen below the Rs. 129 mark,” he said.
The source further said that due to a rumour *that the Government of Sri Lanka would keep away from issuing longer tenure Treasury (T) Bonds, that had had a positive impact on the money market, with yields of T Bonds of 2014 maturity going below the one year T Bill rate to be trading at the 12½-12.75% range, the 2015 maturity at 12.90% and the 2018 maturity at 13.10% as opposed to the previous day’s 13½-13.60% levels, he said.
The one year T Bill maturity at last week’s auction fetched a 13.02% weighted average yield (WAY).
Previously the ER which had been stable at the Rs. 132 level for a while in interbank spot trading against the $,  appreciated to the Rs. 131 level over a period of a week by Monday and held on to those levels on Tuesday and on Wednesday as well, before appreciating to the Rs. 129 level on Thursday, while the benchmark T Bill yields which had had “slowly” being edging up in recent weeks, reversed this trend by declining the previous week, due to possible state intervention, whilst being stagnant the week before, also possibly due to this measure (see also page 35).
Meanwhile FDIs are needed to bring stability to the ER, create jobs, increase production, earnings and exports in a country.
And a stable ER and interest rate regime brings with it predictability, at least as far as those economic indicators are concerned (as opposed to uncertainty), ingredients required to bring in investor confidence, another being political stability.
A stable ER also keeps the prices of imported goods under control and therewith inflation, essential for an import dependent economy such as Sri Lanka, with inflation control also being top priority among foreign investors as it deters the necessity of giving ad hoc salary increases to staff in order to combat inflation (see the lead story in The Sunday Leader business pages of 29.4.12.).
“The ER didn’t weaken to the Rs. 140 level as predicted by some,” he said.
This was in the context that when state owned Central Bank of Sri Lanka (CBSL) gave “greater flexibility” to the ER due to the rapid decline in its foreign exchange (forex) reserves on February 9 (previously protecting it at administered rates), the ER from the Rs. 114.30 levels then, rapidly declined to the Rs. 134 levels in the space of a few months, which prompted an opposition lawmaker to then say that the ER would fall to the Rs. 140 levels.
A weak ER hits the poor, the vulnerable and the fixed wage earner the most, as Sri Lanka is an import dependent economy, relying on imports for basic essentials such as fossil fuels, wheat flour, dhal, medicines and sugar, resulting in the prices of such to rise, in a scenario of a deteriorating ER.
But as events proved, this didn’t happen, ie the ER deteriorating further to the Rs. 140 levels, aided and abetted at times due to CBSL’s intervention in the forex market in “small” dozes when there was pressure for the rupee to depreciate further, coupled with certain measures taken by CBSL to “kill” import demand, such as by the “free float” of the ER which has led to its rapid depreciation; increase in CBSL’s policy rates, vehicle import taxes, administered energy, milk powder, bread and cement prices;  bus fares and capping bank credit growth to 18% year on year this year, whilst allowing such a margin to appreciate by a further 5%, provided that the additional quantum is derived from foreign sources.
However that may be, neither has the ER strengthened to the Rs. 125 levels or below thus far as predicted by President Mahinda Rajapaksa, CBSL Governor Ajith Nivard Cabraal and Treasury Secretary Dr. P. B. Jayasundera recently.
The source further said that one has to give time for FDIs to flow in. According to available statistics, FDI inflows in the first six months of the year were $ 452 million (The Sunday Leader business pages of 16.9.12.), while the BoI targets a $ two billion FDI inflow for the full year (The Sunday Leader business pages of 29.7.12.) and the IMF, a lower $ 1.5 billion figure.
On the possible repercussion to growth and investment goods imports due to the slowing down of imports as a result of these constrictive import measures? The source said that such a “phenomenon” would be temporary. As it’s, investment goods imports fell by 21% year on year in July (see the business pages of The Sunday Leader edition of 16.9.12.).
Meanwhile interbank volumes, including forward bookings were in the region of $ 30-40 million on Monday, a day which saw the ER appreciate by a further 25 Sri Lanka cents (over that of the previous day’s (September 21) close) to be quoted at the Rs. 131 levels and held on to those levels on Tuesday’s and Wednesday’s trading as well, before appreciating to Rs. 129 on Thursday, the source said (see also the lead story in last week’s business pages of this issue’s).
He further said that in the money market, the distortion in regard to the yield of the 2014 maturing T Bond corrected itself, by gaining by 25 basis points (bps) to the 13.25% level in secondary market trading, before falling by 10 bps to 13.15% on Wednesday and falling sharply to the 12½-12.75% level by Thursday .
On September 21, the yield of this tenure fell by 50 bps due to a mix of demand by state controlled players coupled with possible foreign interest to 13%, lower than the one year T Bill yield fetched at that week’s auction which was 13.30%.
On the possible impediment to stabilize rates due to CBSL’s huge stock of T Bills of over Rs. 200 billion? The source said that CBSL has thus far been managing the situation well, avoiding the temptation of increasing its T Bill holdings further by printing and lending new money to the Treasury, a situation which might cause further inflationary pressure on the economy, ie tending for prices to move up at the cost of hurting the poor, the vulnerable and the fixed wage earner the most.
On the market’s illiquid situation, a primary cause for rates to rise? The market which was illiquid by Rs. 13,510 million the previous market day (September 21), saw this being reduced to Rs. 5,964 million on Monday due to foreign inflows, which shortfall was met by a combination of a reverse repo auction by the CBSL (Rs. 5,000 million at a 9.67% weighted average yield (WAY)) and the balance by its reverse repo standing facility at the 9.75% interest rate.  On Tuesday the market was illiquid by Rs. 6,400 million on certain counters, of which Rs. 5,000 million was met by a reverse repo auction at a 9.67% WAY and the balance through its 9.75% standby reverse repo window and on Wednesday it had come down to Rs. 2,000 million, which shortfall was met by CBSL’s reverse repo auction window at a 9.69% WAY, while the market’s shortfall fell further to Rs. 466 million by Thursday, which was met by CBSL’s standby reverse repo facility. The diminishment of market’s illiquidity is due to the receipt of foreign exchange inflows.
* “Rumour” according to another source was “reports “(see connected story found on page 35).

Rupee Weakens, Illiquidity Increases
Money market’s illiquidity which was a mere Rs. 442 million on certain counters on Thursday, shot up to Rs. 8,179 million the following day Friday, probably due to Government of Sri Lanka’s (GoSL’s) foreign debt servicing or due to banks having to meet the 8% statutory reserve ratio requirement by the weekend or due to a mix of both (see also page 35).
Rise in market illiquidity also had an impact on the Treasury (T) Bond secondary market, with the yields on 2014, 2015, 2016 and 2017 maturing Treasury (T) Bonds rising by 30, 25, 20 and 15 basis points (bps) to 12.30%, 12.50% and 12.60 % (ie both 2016 and 2017 maturities) respectively with sellers overtaking buyers, a source told this newspaper. The market is being subject to a correction, he said Meanwhile the weighted average rate (WAR) of gilt edged T bill backed overnight market repurchase transactions gained by one bp over the previous day’s close to 9.65%, though the WAR of call money transactions stagnated at 10.55%. Central Bank of Sri Lanka met Rs. 6,000 million of this market shortfall through a reverse repo auction at a 9.70% weighted average yield (WAY), one bp more than its previous WAY of 9.69% of Wednesday’s (there was no reverse repo auction on Thursday), while the balance shortfall was met by its 9.75% reverse repo standing facility.
In other developments, the exchange rate (ER) which strengthened to Rs. 129 against the US dollar in interbank spot trading on Thursday, weakened to the Rs. 129.50 levels on Friday on the back of import demand, the  source said.
He attributed the sharp gains made by the ER on Thursday due to exporter panic on expectations that the ER will strengthen to the Rs. 125 levels, as had been claimed by GoSL VIPs previously.
Volumes in the foreign exchange market on Friday were however large, he said, with main contributions to the volumes of a larger magnitude coming from a handful of players, especially when it came to exporter play, he said.