Foreign investors exit Sri Lanka rupee bonds for second week

ECONOMYNEXT – Foreign investors have sold down 12 billion rupees of government bonds in the week to August 28, after selling over 13 billion rupees of bonds in the previous week.

Foreign investors started selling bonds shortly before a rate cut in August, as the rupee started to fall after large volumes of money was printed apparently to force down a call money rate.

The gap in yields between Sri Lanka dollar and rupee bonds have narrowed in recent months, while depreciation has also worsened in recent years.

Sri Lanka’s rupee has collapsed from 131 to 182 since 2015, with the operation of a ‘flexible exchange rate’ involving printing money to keep rates down artificially while trying to defend a peg and collect forex reserves.

Until August the central bank was buying dollars and steadily mopping up inflows amid weak bank credit, keeping an exchange rate peg stable, despite some selling by bond holders

But the central bank suddenly stopped mopping up inflows around in late July, and started printing money actively in August.

After keeping unsterilized excess liquidity from the acquisition of foreign assets for an extended period of time, the central bank then started printing money. Then the exchange rate was let go without taking away the excess liquidity.

The central bank also engaged in a disruptive sell down of its domestic assets around August 16, printing money before and after the transaction, in a move that puzzled outside observers.

On August 29, all excess liquidity went out of the interbank system. By August 31, 15 billion rupees was injected overnight at 7.40 percent, still far below the 8.0 percent ceiling policy rate, while other banks borrowed 14 billion rupees overnight.

The injected volumes rise when interventions are made in the forex market (sterilized forex sales). The central bank is also terminating term reverse repo deals made in August, widening the gap.

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Sri Lanka has seen monetary instability due to targeting an exchange rate and suppressing short term interest rate spikes with large volumes of cash injections.

In 2019 however bank credit has been weak or negative weak, indicating that the credit system can absorb some levels of bond sales if money was not printed. (Colombo/Aug01/2019)

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