Room For Money, Forex Markets To Further Deteriorate

• GoSL’s External Commitments Add To Troubles

The exchange rate  (ER) weakened by 75 Sri Lanka cents (SLc) week on week (WoW) by Friday, while Treasury (T) Bond yields in secondary market trading “unexpectedly” strengthened by 10-15 basis points (bps) on Wednesday and held on to those levels, in a week which saw T Bill yields deepen for the second consecutive week in the primary auctions.
Import pressure even prior to the general festive demand overtaking the foreign exchange (forex) market is having a bearing on the ER, a market source told this newspaper.
The ER closed last week at the Rs. 129.70/129.90 to the US dollar ($) in two way quotes in interbank spot trading, having had closed the previous week at the Rs. 129.00/129.10 levels.
Generally the middle rate is considered as the price at which trades are done in two way quotes.
Meanwhile last week’s T Bill auction saw Central Bank of Sri Lanka (CBSL) reject offers received for the shorter term 91 day (three months) tenure, ostensibly because the market was asking for higher yields, while the weighted average yields (WAYs) for the other two tenures on offer, namely the 182 and 364 day tenures (ie the six months and one year tenures respectively) increased by seven and 11 bps to 11.90% and 12.48% respectively.
In the previous week the WAYs of 91, 182 and 364 day tenures increased by three, six and eight bps respectively, after experiencing sharp consecutive falls in the previous weeks’ auctions. An increase in T Bill yields translates to an increase in Government of Sri Lanka’s (GoSL’s) borrowing costs, which in turn has a cascading effect on market interest rates.
With GoSL’s overarching external commitments having to be met, made worse by falling exports and weak foreign direct investments, there is room for the ER to weaken further and in the backdrop of a liquidity crisis and inflationary pressure bugging the economy, compounded by expected seasonal demand, those would also exert pressure on interest rates (see also page 34).
“With market illiquidity increasing (the gross illiquid status in the market was Rs. 12,158 million on Monday as opposed to Rs. 8,265 million the previous market day which was 19.10.12.), the message is that there is room for rates to move up, not to come down,”  a source said
Meanwhile the ER towards the end of the day’s trading on Friday marginally strengthened by 10 SLc to close the week at the Rs. 129.70/129.90 level in two way quotes in spot trading to the $, while the T Bond secondary market was “quiet” due to investors being more interested in the long weekend than in trading, as a result of which those yields remained unchanged, a source said.
The ER WoW has had depreciated by 70 SLc/80 SLc in two way quotes, having had closed the previous week at the Rs. 129.00/129.10 levels, after having had depreciated by as much as Rs. 1.05  by the middle of last week (see also this newspaper’s last week’s business pages).
On Thursday the ER weakened to  Rs. 130.25  before closing at the Rs. 129.90 levels in interbank spot trading against the $ due to the receipt of inflows later in the afternoon, a  source said.
Those inflows may have been due to the bank in question disgorging $s to the market, having to meet its limits’ obligations, he said.  Limits in the forex market in this instance means the amount of forex ($s) a bank is permitted to keep on an overnight (o/n) basis by the CBSL.               CBSL earlier this year cut banks’ net open positions by 2/3rds in the midst of a balance of payments crisis.
“I believe that the gains made by the ER on Thursday are temporary, as such there is a possibility for the ER to weaken on Friday (October 26),” he had then said. But as events aforesaid proved, the contrary took place, with the ER marginally increasing by 10 SLc.
The source said that in the money markets, also encompassing the Government securities’ market (T Bills and Bonds), those however remained virtually unchanged over that of Wednesday’s close.
Meanwhile the ER at Wednesday’s trading deteriorated to the Rs. 130.10 level (Rs.130.00/130.20 in two way quotes) to the $ in spot, interbank trading due to import pressure, while CBSL rejected bids received for the short term, T Bills of 91 day maturity due to the market asking for higher yields (rates), the source said.
The ER had had depreciated by Rs. 1.05 at that time, over that of the previous Friday’s close.
Two sources were of the opinion that the ER would end the year at the Rs. 132 level, provided there is no CBSL intervention to shore up and protect the rupee in the interim.
The state stayed away from the forex market on Wednesday, a source said. Volumes traded were however thin, he added. Seasonal demand is yet to impact on the forex market, the source further said.
The current rains being a soother to the forex market because it will minimize demand for the expensive imported fossil fuels for power generation? The source said that two or three days of rains will not change the equation, other problems, like floods for instance may then occur, he said.
Meanwhile Wednesday’s T Bill auction saw bids for the 91 day tenure rejected, while  that of the 182 and 364 day tenures increased by seven and 11 bps to 11.90% and 12.48% respectively. An increase in T Bill yields translates to an increase in GoSL’s borrowing costs, which in turn has a cascading effect on market interest rates.
The 91 day tenure at the previous week’s auction fetched a WAY of 10.66%, a WoW increase of three bps. However in the T Bond secondary market, prior to Wednesday’s T bill auction, yields across the board declined by about 10-15 bps on that day, before witnessing hardly any trades after that auction, by going into limbo, a source said.
Prior to the auction, yields of T Bonds of 2015, 2016, 2017 and 2018 tenures fell to 12.65%, 12.75%, 12.80% and 13% respectively. Inflationary pressure (the point to point increase in the Colombo Consumers’ Price Index administered by the state controlled Census and Statistics Department last month was 9.1%) and an illiquid status in the money market due to a lack of forex inflows are however attributed as reasons for pressure being exerted on interest rates.
At the beginning of last week on Monday, conditions in the forex and money markets deteriorated further due to a triple mix of import pressure, a few banks facing liquidity problems and GoSL’s external commitments, a source said.
As a result,  the ER then depreciated by 75 SLc  to Rs. 129.80 to the $ in interbank spot trading, while the market’s illiquid situation increased to Rs. 12,158 million in certain counters, CBSL data showed.
Another source said that quotes in the forex market went up to as high as the Rs. 130 level (a one rupee deterioration of the ER), before closing Monday at the Rs. 129.55/129.70 level in two way quotes.                     The following day Tuesday, it depreciated to the Rs. 129.85/130.10 level due to seasonal import demand.
But with remittance inflows expected in the next couple of days, the ER may strengthen to the Rs. 129.50 levels before GoSL’s external commitments such as the settlement of oil bills taking over the market, thereby exerting pressure on the ER to weaken, a source said on Tuesday.
If there is no state intervention to protect the ER, it may well end the year at the Rs. 132 level, he said. Seasonal pressure is building up on the ER. However in the past two weeks imports and exports have had squared off, this source said on Tuesday.
An illiquid situation in the rupee market also drives up rates. CBSL met part of Monday’s liquidity shortfall through a 31 day term reverse repo auction at a 9.83% WAY, selling Rs. 6,000 million to the market.
“But with 91 day T Bills fetching a 10.66% WAY, this in effect means that the market can borrow from the CBSL at 9.83% and invest such moneys on  those T Bills, thereby earning an interest rate which is 83 bps more than its borrowing costs from CBSL,” another source said.

This translates to GoSL paying the market a premium on investments made by the latter on T Bills after borrowing from another state agency namely the CBSL at a lower cost to make such investments, he said.
“With illiquidity increasing (the gross illiquid status of the market was Rs. 12,158 million on Monday as opposed to Rs. 8,265 million the previous market day which was 19.10.12.), the message is that there is room for rates to move up, not to come down,”  the source added.
However this illiquid status in the market in certain counters tapered off to Rs. 136 million the following day Tuesday, probably due to the absence of any offmarket activity by GoSL (see below) that would have had precluded from exerting further pressure on the market’s liquidity status, buttressed by Rs. 12,158 million infused by CBSL through its various reverse repo windows the previous day.
There were no reverse repo auctions in the subsequent days of last week.
Nevertheless in the previous weeks CBSL/GoSL tried to control both the ER and interest rate, an action which they tried before the 3% devaluation of the ER in Budget2012 last November, followed by a virtual free float of the ER three months later in February.
That also resulted in them giving up trying to bridle interest rates, as a consequence of trying to stop the further deterioration of the island’s forex reserves by making the ER more expensive through the action of a “free float,” and also by “market determined” interest rates.
“A similar situation now appears to be arising and may reach a crescendo after the presentation of Budget 2013 in Parliament next month, following which GoSL/CBSL will give up trying to defend both the ER and interest rates,” the source speculated.
“I believe there is room for T Bills yields to return to their recent peaks after Budget 2013, where the one year (364 day) T bill yield fetched 13.30% as opposed to the current yield of 12.48%,” he said, as an example.
GoSL/CBSL uses captive sources such as the EPF to bridle interest rates by using those to invest in T Bills as was the case recently, at administered (low) rates, which yields are considered as catalysts to determine the movement of market interest rates.
“CBSL says that they can meet the market’s liquidity requirements, this is the same record they played prior to Budget 2012 and the 3% rupee devaluation that followed, complemented by the virtual free float of the ER three months later,” he said.
During that period CBSL infused liquidity into the market by subscribing to T Bills, but on the flip side that created inflationary pressure on the economy.
On the ER, another source speculated that there is room for it to further deteriorate to the Rs.132 level, complementing what another source said (see above).
Inflows are not sufficient to meet outflows.
GoSL’s external commitments that have a bearing on both the forex and money markets are foreign debt servicing and the settlement of oil bills, when such activities take an offmarket complexion in order to reduce market pressure on the ER; that however disturbs the market’s liquidity situation as appears to be the case now.
That liquidity crisis in money markets is compounded, particularly so when forex inflows are few and far between. GoSL in an offmarket activity creams off the rupee liquidity from the market to buy the necessary forex from CBSL in exchange, to meet such commitments, generally at administered rates, leaving little or no room for the market to meet its own liquidity requirements as a result.
Yet another source said that banks, for various reasons, such as having to meet certain commitments the following day, do not park all of their excess liquidity with CBSL through its repo window. “They hold on to such, and that too creates an illiquid situation in the market at least temporarily,” he claimed.
“On Monday, the ER deteriorated to the Rs. 129.90 levels, but at which price we saw exporters coming in and encashing their $s believing that it’s a good price to sell their greenbacks, that prevented the ER from falling further,” another said.
Meanwhile to meet the market’s liquidity requirements, on Monday CBSL held a one month (31 days) term reverse repo auction from which it sold Rs. 6,000 million to the market at a 9.83% WAY, while a further Rs. 4,000 million was fed to the market through an o/n reverse repo auction at a 9.70% WAY and the balance Rs. 2,158 million through its o/n reverse repo window at its standard 9.75% policy rate.
On the previous day (19.10.12.), data showed that the market’s gross liquidity requirement was Rs. 8,265 million, which was met by CBSL’s reverse repo windows.
On Monday, T Bond yields in the secondary market deteriorated by 10 bps on the back of sluggish activity, another source said, with the most actively traded, ie the 1.4. 2014 maturing Bond, seeing deals being executed at the 12.80%-12.95% levels, he added.
When the forex market is active the Bond market is virtually dead, a source said. “We see such wide spreads as was witnessed in the 1.4.14. maturing Bond on Monday because of speculation,” he added.
Meanwhile the Bond market continued to be quiet the following day Tuesday as well, another source said, before declining by 10-15 bps on Wednesday, prior to that day’s T Bill auction, after which it was dogged by inactivity on that particular day, with the placidity continuing throughout the rest of last week.