ER Holds At Rs. 130

• Avurudhu Rupee Commitments Bear on Exporters

The exchange rate (ER) held at the Rs. 130 levels to the US dollar ($) at Wednesday’s, Thursday’s and Friday’s trading as exporters began encashing their $ proceeds to meet their local commitments, a market source told this reporter.
“In the event they persisted in holding on to their $ proceeds with the expectation that the ER would depreciate further, then they would have had no option other than to borrow rupees from the market, and that means that their costs would go up, in an environment where interest rates are rising,” the source said.
“Importers have had already made their Avurudhu purchase bookings, so there is no pressure on the ER from that area,” he said.  After the Avurudhu season there may even be a possibility of the rupee strengthening, the source said.
“Earlier we thought that the ER would bottom out at the Rs. 120 levels, but that was not to be,” he said (see also the business pages of this newspaper’s 11.3.12. edition).
And in regard to interest rates,  Wednesday’s weekly Treasury (T) Bill auction saw the weighted average yields (WAYs) of T Bills of 91 (three months) and 364 day (one year) tenures rise by 33 and 35 basis points (bps) to 10.75% and 11.11% respectively.
T Bills of six months (182) day maturity were not offered at this auction, presumably because the market was asking far higher yields than that which the Government of Sri Lanka (GoSL)/Central Bank of Sri Lanka (CBSL) was prepared to pay. In the previous auction, T Bills of 182 day maturity fetched a WAY of 10.46%.
A measurement of how market interest rates have had risen recently maybe gauged by the fact that commercial banks’ average weighted prime lending rate (AWPR) in the week ended March 16 has had gone up by 302 bps year on year (YoY) to 12.27%.
AWPR is the borrowing cost for blue chip borrowers who are few and far between. Sri Lanka’s economy is mainly run by the SME sector which is considered as high risk borrowers by the banking system. As such the interest charged on their borrowings is far higher than the 12.27% charged on good borrowers.
When borrowing costs increase, it hurt investments, the result of which is that it stultifies job creation, a situation that may lead to political and social instability in a country.
“After the ER fell by Rs. 5 due to importer pressure in spot trading on Monday, CBSL allegedly intervened in the foreign exchange (forex) the following day Tuesday (March 20), defending the ER at various levels beginning at Rs. 130 to the $, another market source said. It strengthened to Rs. 129.50 and again fell to Rs. 130, with CBSL allegedly moving in to prevent its further fall.
However this was disputed by other sources who said that the reason behind state owned Bank of Ceylon (BoC), generally considered as a CBSL/GoSL agent, selling $s at Rs. 130 a unit in spot interbank trading did not necessarily mean that they were acting according to the dictates of GoSL/CBSL by being a conduit to diminish CBSL’s reserves for the gain of preventing the ER to further depreciate. “They may have had genuinely got inflows which they sold to the market,” he said.
After all exporters too have rupee commitments to make, he said. Now the Avurudhu seasonal pressure is round the corner, they have to pay their staff their bonuses, so, naturally they will start encashing their $s to meet those commitments, he said. And they have had already made their Avurudhu imports, so pressure on the ER on that score has been eased, he said.
“I feel that the ER will settle down at the Rs. 130 levels ‘with a few rupees plus or minus scenario,’” the source said.
Earlier on Monday when the ER fell by Rs. 5 to Rs. 131, he then said that the position is frightening and found fault with CBSL for not taking preventive measures to block its steep fall.
As if in answer to his prayers, CBSL allegedly intervened in the forex market the following day, defending the ER at the Rs. 130 levels, an artificial strengthening of the local currency by Rs. 1 over its previous day’s (Monday’s) close of Rs. 131. However as said aforesaid, the claim that CBSL intervened in the market on Tuesday is disputed.
That day (Monday, March 19), the ER fell to a record low Rs. 131 to the $ in interbank trading on the back of panic demand for the greenback by importers and the reluctance by exporters to encash their $ proceeds even at attractive rates of over Rs. 130 to the $ on offer, a source said.
“Frightening” is how another source described the sharp depreciation of the ER by Rs. 5 in a day on Monday. The ER which closed last Friday (March 16) at Rs. 126, before opening at Rs. 125/80 on Monday morning, declined to Rs. 131 during the day on Monday.
A depreciating ER makes imports more expensive, hitting the poor the hardest, in an import dependent economy such as that of Sri Lanka’s.  “And CBSL is doing nothing about it,” he added.
“Exporters, after having got their fingers burnt before, by booking forward at nominal premiums, ie beforelast November’s surprise rupee devaluation, coupled with last month’s sudden rupee free float, after earlier receiving assurances from CBSL that the local currency won’t be depreciated, first, before November’s devaluation and then afterwards, ie prior to last month’s free float, now they don’t believe the encouraging stories floated around by the authorities in regard to the ER,” he said.
As a result, the drying up of $s in the market due to exporters reluctance to encash their $ holdings coupled with pressure on the ER to depreciate further due to importer demand, has resulted in the current status quo in the forex market, he had said on Monday.
However that may be, CBSL held a repo auction at Monday’s trading and drained off Rs. 14.2 billion worth of additional liquidity from the market, by selling part of its T Bill stock in lieu.
As a result, its T Bill holdings fell from Rs. 248.4 billion as at March 16 to Rs. 228.6 billion by March 19, a figure which held till the weekend. Additionally CBSL reduced its T Bills by that amount by also absorbing another Rs. 9.3 billion in excess liquidity from the banking system from its repo window and giving banks an equivalent value of T Bills in lieu as security.
This excess is believed to have had been mainly caused by EPF, which on March 16  made an equivalent of Rs. 14.3 billion in foreign exchange ($ 114.6 million) by selling its stake in blue chip John Keells Holdings plc (JKH) to a foreign fund (see also the business pages of this newspaper’s last week edition).
The equivalent $s accrued to the EPF by this sale are believed to have had been in turn bought by CBSL through the banking system, with CBSL releasing rupees in lieu to EPF also through the banking system, which “excess” liquidity in turn was creamed off by CBSL through its overnight (o/n) repo auction.
When CBSL reduces its T Bill holdings, it also tends to decrease inflationary pressure on the economy as it absorbs an equivalent amount of liquidity from the market in lieu.  But in o/n operations such as this it’s different, because CBSL once more infuses liquidity in to the system the following day, receiving the T Bills which had surrendered to the banking system the previous day in lieu.
Retirement of T Bill holdings, as opposed to its reissuance, held by either the CBSL or by the market or by both, may be a better way to release inflationary pressure on the economy, or otherwise by auctioning off CBSL’s T Bill stock to the market (see also connected story found on page 41).
By Thursday, CBSL’s T Bill holdings had further reduced to Rs. 224.4 billion, while excess liquidity drained out from both the repo auction and the repo window amounted to Rs. 27.8 billion. The increasing levels of liquidity in the market may be due to the aforesaid inflows.