ECONOMYNEXT – Sri Lanka’s implied forward exchange rates have plunged in dollar/rupee swap markets as money printing depressed rupee yields and the forex shortages and downgrades that came in its wake drove up domestic dollar yields to double digits.
Outright trading in the spot and forward markets have dried up after the central bank ordered dealers not to trade above 200 to the US dollar.
Giving forward cover to importers has already been banned. Interbank forwards are permitted to facilitate swaps.
Swap rates have been quoted and traded at steep discounts implying one year forwards at below 180 rupees with inflation differential inverted despite having a weak currency and money printing draining forex reserves steadily.
Spot/1 year swaps are quoted at a discount of 1700/1500 bp, spot/6 month at a discount of 900/840, the spot/3 month at 475/440, spot/2 month at 310/280, spot 1 months at 150/130 and spot/two weeks at 55/40, market participants said.
Spot trades are not permitted above 200 to the US dollar.
With no trading in the forex market and some running negative net open positions, banks have been forced to limit import letters of credit except to existing clients, market participants said.
Without a working forex market, banks have to run net open positions to cover LCs on the due date.
By buying spot and selling forward through a swap transaction, a bank which is short of forex currency can receive dollars to lend.
Sri Lanka’s central bank has also been receiving dollars through swaps, though the total outstanding has declined recent months, contributing to an overall fall in gross official reserves.
The counter party of the swap who receives rupees can invest the money in treasury bills and buy back the dollars at the discounted rates in the future at which time when the rupee could be weaker.
Effectively the seller at the spot leg gets exchange protection for a rupee investment and also gets paid for it.
Sri Lanka’s central bank offered zero cost swaps for anyone who wants to borrow dollars, though in the market, swaps are going at a discount.
Sri Lanka this week raised fuel prices, in a bid to reduce pressure on domestic dollar markets. However Sri Lanka has over 110 billion rupees of excess liquidity in money markets, indicating potential reserve losses of around 500 million dollars at current exchange rate if credit continues to grow.
Sri Lanka has a soft-pegged exchange rate regime with a sterilizing central bank in the style of several set up in South and Central American and Asia by the Latin America unit of the Federal Reserve to do Keynesian counter-cyclical policy.
Analysts and economists had earlier called for the re-establishment of a currency board which was abolished to create the Latin America style central bank in 1950, to re-establish Singapore, Hong Kong, Macau, Brunei or at least Dubai, Kuwait style monetary stability.
However several of the central banks created, or their original gold standard monetary law were tinkered by Fed ‘money doctors’ have ended up in dollarization. (Colombo/June16/2021)