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Thursday December 1st, 2022

Sri Lanka makes helicopter drops of new money despite soft-peg

ECONOMYNEXT – Sri Lanka’s central bank has made large helicopter drop style liquidity injections, despite the lack of a freely floating exchange rate regime, data shows, and the credibility of the island’s soft-peg has been severely undermined despite weak private credit.

As the credibility of the peg was weakened the central bank slapped import controls but no effort was made to withdraw liquidity.

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Sri Lanka had monetary stability up to January 2020, despite foreign selling in rupee bonds, mostly helped by weak private credit.

But on January 30, the central bank cut rates, in a risky move as fiscal policy had deteriorated with a series of tax cuts, especially value added tax and budget deficits were set to worsen, and private credit would go through a cyclical recovery.

Analysts had warned that Sri Lanka’s obsession with short term rates would lead to monetary instability.

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In late February 2020, a 24 billion rupee central bank profit transfer was made to the Treasury as a liquidity injection in a relatively small helicopter drop which was not permanently sterilized, mopped up.

Analysts had earlier advised that profit transfers be halted to boost reserves and if they are done, to transfer foreign reserves, recognizing up front that the rupee would have to be defended against the liquidity injections.

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Sri Lanka excess liquidity spike in Feb from central bank profit transfer

On March 13, the central bank’s Treasury bill stock went up from 78 billion rupees to 128 billion rupees as a 50 billion rupee ‘helicopter drop’ was made, which was not formally disclosed to the market, despite global uncertainty.

Excess liquidity in money markets jumped from 30 billion rupees to 74 billion rupees.

On March 16, the following Monday rates were cut and a statutory reserve ratio (the share of deposits that banks have to place at the central bank) was also cut by 100 basis points, potentially releasing another 50 billion rupees in liquidity with effect from March 17, despite global uncertainty.

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On March 17, excess liquidity jumped to 118 billion rupees.

Chillingly, markets were told more liquidity would be given.

With low rates and excess liquidity, domestic banks also started to buy Sri Lanka dollar bonds, some of which were trading around 30 percent below par, while exporters and importers were also concerned, leading to a deterioration of the credibility of the peg.

Sri Lanka’s dollar bonds began to yield higher than rupee bonds.

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The central bank then imposed trade controls and banned banks from buying dollar bonds. In Sri Lanka there is a strong belief that monetary instability and currency pressure is related in some way to imports (trade) and not liquidity.

In forex markets the gap between spot and forward rates narrowed and the forward premiums almost disappeared.

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Mercantilists have also put forward an idea that the 2018 monetary instability came from sales of rupee bonds, conveniently forgetting that the rupee had been busted from 4.70 to the US dollar when Sri Lanka’s soft-peg was set up, to around 110 to the dollar, solely due to money printing and loss of credibility of the peg, when there were no foreign investors in rupee bonds.

In the 2011 and 2012 the balance of payments crisis, foreign investors in rupee bonds largely stayed put.

Pegged countries that do not inject liquidity recklessly in times of uncertainty, and maintain monetary stability and the credibility of the peg, are able to benefit from low global rates and monetary easing in the anchor currency (USA) and raise money abroad and roll-over debt at very low rates.

Analysts had warned the central bank not to inject liquidity because it leads to loss of foreign reserves when the newly minted money turns into imports and the peg is defended, or if the peg is not defended the rupee falls. Usually both outcomes occur in Sri Lanka.

When liquidity is injected on a net basis the central bank loses the ability to collect forex reserves by sterilizing the current account (mopping up in flows) undermining the country’s ability to settle dollar loans and a rapid deterioration of reserves, which then leads to a downgrade.

Analysts had warned that Sri Lanka did not have enough rating space to narrowly target a call money rate with excess liquidity which had been identified as a key risk to the economy.

“Sri Lanka will soon run out of rating space to tap capital markets if the flexible exchange rate/call money rate targeting continues in the next recovery space,” an analyst warned in December when value added tax was cut, even before the Coronavirus crisis.

“If rates are cut further and money is printed, the recovery in 2020 will be short-lived or not at all, and another currency crisis will be generated and downgrades will follow.”

Unlike in the US, when liquidity injected by the Fed moves out of the country to fill dollar liquidity shortages in the world, sometimes pushing up the US dollar against other currencies, the opposite happens in a soft-pegged country where the domestic money is not in demand overseas.

Sri Lanka’s anti-Coronavirus activities driven by the health sector and the military up to now have been far ahead of many countries of the world, and are seen in very few countries, including Vietnam, South Korea and Russia.

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The government has said it will not cut fuel prices, in another move that is likely to help state finances. (Colombo/Mar27/2020)

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Sri Lanka’s inflation eases to 61-pct in November

ECONOMYNEXT – Sri Lanka’s 12-month inflation in the capital Colombo fell to 61 percent in November 2022 from 66 percent in October as price stabilized after interest rates were allowed to go up and the exchange rate was pegged around 360 to the US dollar.

The widely watched Colombo Consumer Price Index fell absolutely 0.5 percent to 242.6 points in November after falling .04 percent in the October.

Food prices fell 1.5 percent after falling 2.0 percent a month earlier. The sub-index containing gas fell 0.5r percent and transport fell 3.6 percent.

But some services continued to go up, as relative prices adjusted to the steep fall in the currency after two years of money printing to suppress rates.

Health costs went up 5.7 percent. Furnishing and routine maintenance rose 0.4 percent.

Sri Lanka’s central bank hiked policy rates to 15.5 percent in April and pulled back on longer term money printing, allowing market rates to go to around 30 percent.

The exchange rater is pegged around 363 rupees with a surrender rule where banks are forced to sell dollars to the central bank for new liquidity.

The ongoing currency and inflation crisis is the worst in the history of the central bank.

Sri Lanka’s Latin America style central bank was set up in 1950 giving powers to the country’s macro-economists the power to mis-target rates, create currency crisis and high inflation. (Colombo/Nov30/2022)

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Sri Lanka shares close at one-month high

ECONOMYNEXT – Sri Lanka shares closed at one month high on Wednesday gaining for the fourth session on news that government is in talks with ADB and World Bank to get a 1.9 billion dollar loan facility, brokers said.

The main All Share Price Index (ASPI) closed 3.3 percent or 276.02 points higher at 8,651.23, highest index gain in since November 01.

“Investor participation improved on the back of confirmed talks with multilateral and bilateral lenders including world banks and ADB for USD 1.9Bn after IMF board level agreement is reached,” First Capital Market Research said in it’s daily note.

Former Central Bank Governor Indrajit Coomaraswamy said in a forum on Monday that the government is in discussion with ADB and World Bank to get loans of 1.9 billion US dollars after a reform program with International Monetary Fund is approved

A policy loan now being discussed with the World Bank may bring around 700 million US dollars, Coomaraswamy told a business forum organized by CT CLSA Securities, a Colombo-based brokerage.

The Asian Development Bank may also give around 1.2 billion US dollars most of which will be budget support, he said.

The market witnessed a turnover of 3.3 billion rupees, higher than this year’s daily average turnover of 2.9 billion rupees. This is the highest turnover generated since October 04.

In the last few sessions market gained after Central bank governor said market rates should eventually ease despite the fears of a domestic debt restructuring as inflation falls, increased liquidity in dollar markets, and the inter-bank liquidity improves.

In the past sessions, the index continued to fall on the speculation of a local debt restructuring although no proper decision has been taken so far.

The market saw a foreign inflow of 39 million rupees. The total net foreign inflow stood at 18.33 billion rupees so far for this year.

The more liquid index S&P SL20 closed 3.4 percent or 89.78 points higher at 2,730.08.

The ASPI has fallen 0.5 percent in November after losing 13.4 percent in October.

It has lost 29.2 percent year-to-date after being one of the world’s best stock markets with an 80 percent return last year when large volumes of money were printed.

Sampath Bank pushed the index up to close at 10.9 percent to 36.6 rupees.

Other top gainers were Browns Investment gained 15.4 percent to close at 7.5 rupees and LOLC gained 9.4 percent to close at 411.3 rupees.(Colombo/Nov30/2022)

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Sri Lanka bonds, T-bills ease, overall market dull

ECONOMYNEXT – Sri Lanka’s treasury bonds eased and T-bill yields fell on the speculation on talks with ADB and World Bank to obtain financial aid but the over all market was dull on Wednesday while the Central Bank’s guidance peg remained unchanged, dealers said.

“During the day, secondary market witnessed some buying interest on the back of speculations on yields easing while talks about financial aid from ADB and World Bank further strengthened interest,” First Capital Market Research said in it’s daily note.

A bond maturing on 01.05.2024 closed at 32.00/60 percent on Wednesday, down from 32.30/90 percent on Tuesday.

A bond maturing on 07.07.2025 bond closed at 30.80/31.30 percent up from 30.30/31.25 percent on Tuesday.

A bond maturing on 15.05.2026 closed at 31.00/30 percent down from 31.10/31.30 percent on Tuesday.

The three-month T-bills closed at 32.30/33.25 percent, down from 32.60/33.00 percent.

The Central Bank’s guidance peg for interbank transactions remained unchanged at 363.19 rupees against the US dollar.

Commercial banks offered dollars for telegraphic transfers between 371.79 and 372.10 for small transactions, data showed.

Buying rates are between 361.79 – 362.00 rupees. (Colombo/Nov 30/2022)

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