Money Market’s Illiquid Status Deepens

The money market’s illiquid status deepened at Friday’s (September 14) trading, forcing state owned Central Bank of Sri Lanka (CBSL) to hold a reverse repo auction after a lapse of 10 days to meet market’s shortfall.
CBSL, through its reverse repo window met Rs. 3,000 million of this shortfall at a weighted average yield (WAY) of 9.64%. Additionally another Rs. 870 million was fed through its standard reverse repo window at the standard 9.75% interest rate.
On September 4, Rs. 3,500 million was lent to the market through CBSL’s overnight (o/n) reverse repo auction at a 9.65% WAY, one basis point (bp) more than Friday’s 9.64% WAY.
When the money market is short, that tends rates to rise (both deposits and lending), one to attract liquidity to the market, and the other also due to the “supply and demand” theory of too little supply to meet demand, that tend to make lending rates to rise.
CBSL data showed that commercial banks’ weighted average prime lending rate (AWPR)-lending to blue chips, in the week ended Friday rose by 32 bps week on week (WoW) to 14.14%. This figure a year ago was 465 bps less at 9.49%.
Similarly commercial banks’ average weighted lending rate (AWLR) in July was 15.02%, whereas a month ago it was 14 bps less at 14.88%, while a year ago it was 128 bps less at 13.74%.
Likewise commercial banks’ average weighted deposit rate (AWDR) last month was 8.95%, whereas in July it was 25 bps less at 8.70%, while a year ago it was 255 bps less at 6.40%. Meanwhile commercial banks’ average weighted fixed deposit rate (AWFDR) last month was 11.54%, a 27 bp increase over July and 343 bps more than what it was a year ago.
When lending rates rise it may also lead to an increase in banks’ bad debts with a possibility of posing a systemic risk to the system. Similarly when lending rates rise it stultifies growth as it deters borrowing s because borrowings have become more expensive to feed factory expansion and new industries being set-up, which in turn hampers earnings and job creation, with a danger of creating social, political and economic instability in the country.
Market shortfall (where CBSL had to resort to its reverse repo facility), was first experienced last week on Thursday, which resulted in CBSL meeting this need through its standby reverse repo window standby facility at the 9.75% rate for a Rs. 639 million amount.
Meanwhile the last time CBSL used its reverse repo facility prior to Thursday was on Friday, September 7, where Rs. 984 million was fed that way to the market, a week where the market was continuously short.
However on Thursday the weighted average rate (WAR) of call money transactions (interbank borrowing rate) remained stagnant at 10.59%, the same as that of the previous day (Wednesday’s) rate.  O/n gilt edged Treasury (T) Bill backed market repurchase transactions’ WAR however crept up by one bp to 9.63% on Thursday.
The following day Friday, the WAR of call money transactions however declined sharply by 12 bps over Thursday’s close to 10.47%, while market repurchase transactions’ WAR declined by three bps to 9.60%.
Meanwhile at the beginning of the week on Monday, the money market, which, in the previous week was continuously short in certain counters thereby forcing CBSL to lend liquidity to the market through its reverse repo facilities, however changed this trend then, with the market throwing up an excess liquidity figure of Rs. 2,863 million.
This situation arises when state owned CBSL buys $s from the market, thereby strengthening its foreign exchange (forex) reserves’ position, while simultaneously paying the market in rupees for such purchases in lieu, thereby creating a rupee liquidity situation in the market.
Similarly the market’s excess liquidity diminishes when Government of Sri Lanka borrows rupees from the market to buy US dollars from CBSL’s forex reserves to meet foreign debt service commitments.
CBSL however drained out Rs. 2,699 million worth of this excess liquidity from its o/n repo auction facility at a 9.42% WAY on Monday, while the balance was swallowed up by its repo standing facility, paying the market a 7.75% interest rate on an o/n basis.
CBSL, prior to Monday (September 10) last held a repo auction on August 30, where it drained out Rs. 6,502 million worth of excess liquidity from the market at a 9.43% WAY, one bp more than that of Monday’s WAY.
The reason for CBSL to drain out excess liquidity from the market from its repo facilities is to minimize inflationary pressure overtaking the economy, ie a situation caused by price increases due to too much of money being made available in the system to buy too fewer goods.
Meanwhile the WAR of call money transactions increased by four bps to 10.59% at Monday’s trading (over that of the previous market day, ie September 7’s WAR), while the WAR of o/n market repurchase transactions stagnated at 9.62%.
A liquidity crisis in the market tends to increase both deposit and lending rates-deposit rates in order to attract liquidity and lending rates, so that there will be sufficient money to payoff depositors, now at the higher deposit rate payable to them.
With regard to the money market’s performance on Tuesday,  a source however had then said that with the possibility of T Bill yields rising further and hitting the 15% rate in tandem with the forthcoming Christmas season, where consumer demand for goods and services is expected to push up interest rates due to increased bank borrowings to feed such an appetite, thereby also exerting pressure on the exchange rate due to import demand, such a higher interest rate regime would help whet foreign investor appetite for government securities (T Bills and T Bonds), thereby flooding the market with more $s.
T Bill yields at the previous week’s weekly primary auction increased by three and five bps each for tenures of 91, 182 and 364 day T Bills to be quoted at 11.44%, 13.12% and 13.16% respectively.
Rise in T Bill rates is a harbinger that market interest rates will also be on the rise.
However that may be, the seemingly unexpected happened at Wednesday’s (September 12) T Bill auction, with the yields for all three tenures remaining flat, week on week. The 91, 182 and 364 day tenures stagnating at the 11.44%, 13.12% and 13.36% levels respectively at this auction.
With CBSL’s huge stock of T Bills, ie some over Rs. 200 billion (it was Rs. 201.8 billion on Wednesday and by the weekend it had increased to Rs. 211.1 billion), that gives it little manoevrability to intervene in money markets in order to stabilise rates, as such intervention means greater inflation in its T Bill holdings because a rate hike may be mitigated by infusing more rupee liquidity to the market, which may be done by CBSL itself subscribing to T Bills that are on offer at the primary auction. But the danger in such an activity is that it may stoke inflationary pressure on the economy.
When there is liquidity it soothens pressure on rates, but when the market is illiquid, that causes upward pressure on rates, both at the deposit and at the lending levels.
Even in secondary market trades yields were subdued, he said on Wednesday.
Meanwhile the source said that the reason why T Bill yields held was because of excess liquidity in the market, as opposed to it being short the previous week. With CBSL’s T Bill holdings remaining at the Rs. 200 billion levels at least for several weeks without being subjected to abnormal increases, as such, excess liquidity created in the market may have had been caused by forex inflows.
When such inflows are converted into rupees, with the ultimate buyer of such forex being CBSL, which is also the sole authority to print rupees and release them to the economy in exchange, that mechanism inflates the market with rupee liquidity, without CBSL having to infuse liquidity by subscribing to T Bills.
Market’s excess liquidity in the three days from Monday to Wednesday were Rs. 2,863 million; Rs. 4,482 million and Rs. 5,332 million respectively, while on Thursday, on a net basis,  the market’s excess liquidity was Rs. 4,259 million.* In contrast in the previous week, ie from September 3-7, the market was short by Rs. 8,260 million in most counters- on September 3, Rs. 5,640 million (September 4),  Rs. 2,920 million (September 5),  Rs. 232 million (September 6) and Rs. 984 million (September 7).
Forex inflows are the answer to stablise rates.
The money market however is also currently swamped with rupee liquidity, thereby reining in rates in the interbank call money market, a source said on Tuesday.
Meanwhile on Tuesday call money’s WAR slipped by two bps to 10.57%  (over that of the previous day Monday’s close) and the o/n market repurchase transactions’ WAR fell by one bp to 9.61%.
However the following day on Wednesday call rates rose by two bps to 10.59% and the WAR in market repurchase transactions by one bps to 9.62%.
In the o/n repo auction mechanism used by CBSL to mop up excess liquidity from the market, Rs. 3,632 million was swallowed up this way at a 9.43% weighted average yield (WAY) on Wednesday (the same WAY as that of Tuesday’s),  while the balance Rs.1,700 million was taken in by CBSL;s standard repo facility of 7.75%.
On the previous day Tuesday,  the o/n  repo auction swallowed up Rs. 4,000 million worth of excess liquidity at a 9.43% WAY, one bp more than the previous day’s WAY, while the balance Rs. 482 million was taken in by CBSL;s standard repo facility of 7.75%.
*On Thursday, CBSL swallowed up Rs. 4,000 million worth of excess liquidity from its o/n repo auction facility at a 9.42% WAY, while through its 7.75% repo standing facility another Rs. 898 million was taken up. However, as certain counters were also short on that day, CBSL through its reverse repo window met this Rs. 639 million shortfall charging the 9.75% standard interest rate.