ECONOMYNEXT – Sri Lanka’s rupee crossed 231 to the US dollar in the over-the-counter market for importers and exporters while 127 billion rupees were injected at the overnight printing rate of 6.0 percent for banks to meet (sterilize) a hike in a deposit margin.
Sri Lanka raised the statutory reserve ratio, a margin that bank must keep with the central bank from 2.0 percent to 4.0 percent effective September 01 but the interbank market was already short despite earlier injections.
The central bank had lifted convertibility for most trade transactions, weakening the rupee.
There is no longer an interbank spot market to establish a uniform and transparent clearing price for the rupee/dollar exchange rate and exporters and importers are ‘shopping’ dollars in an informal OTC market leading to a near floating rate.
Importers are making direct calls to exporters, chief executives and finance managers to persuade them to sell at various rates, while those with dollars are going away from their usual banks to sell.
Some finance officials who did not get the same price as some other exporter had come under criticism for allegedly selling at a lower rate, market participants said. Financial officials do not like to entertain calls, but are increasingly finding it difficult not to do so.
On Wednesday the rupee crossed 230, a psychological level to reach 231 to the US dollar.
“It is a kind of floating rate since convertibility has been lifted for the most part,” EN’s economic columnist Bellwether says.
“However liquidity is still coming from failed bond auctions and some interventions are being done which are also sterilized with new liquidity preventing rates from going up, so the exchange rate does not stabilize.”
The day before the SRR went into effect the market was short by 41 billion rupees, usually an effect of convertibility offered by the monetary authority (dollars sold) and 150 billion rupees had already been printed through the overnight 6.0 percent window.
In order to maintain peg interest rates have to go up after the intervention. But due to the overnight sterilization, liquidity is re-injected.
“This is the classic contradictory policies of a ‘flexible’ exchange rate,” explains Bellwether. “There is no monetary policy to support a firm peg where interventions should lead to a fall in the monetary base and a rise in rates.
“Neither is there a policy to support a float where the monetary base should not be affected by forex inflows and outflows without any dollar sales or purchases by the central bank, which permits the overnight rate to remain fixed along with the monetary base. This is why countries with a Latin America style or an IMF recidivist peg if you like, have severe monetary instability.”
After the SRR hike, another 127 billion rupees was printed through the overnight window to ‘sterilize’ the liquidity short.
Meanwhile, better managed banks which were plus cash, and had deposited 109 billion rupees in the central bank’s excess window cut their holdings to 72 billion rupees to meet the SRR hike.
The overnight call money rate hit the 6.0 percent policy ceiling on September 01, amid the liquidity shortage. Call rates last hit 6.0 percent in May 2020.
Sri Lanka’s bond markets are however still dysfunctional with price controls preventing offered bills being sold.
An August 25 bill auction and a September 02, auction, which failed to sell all securities had led to money being printed.
However the market was already short by 41 billion rupees by September 31, before the SRR hike.
Now overtrading banks are short a total of 277 billion rupees, which may further discourage subscriptions to bonds, analysts say.
It is not clear why authorities raised the SRR before bond auctions were made to function again.
Bond auctions were frozen on Wednesday with no trading and no regular quotes, dealers said.
A solitary 01.12.24 bond was briefly quoted at 8.05/20 percent on September 01, from around 08.05/15 percent levels are day earlier.
Sri Lanka’s economic controls are intensifying as forex shortages worsen amid dysfunctional bond auctions. Unsold bonds are being converted to reserve money, and paid as salaries to state workers and meet other expenses, triggering imports from their recipients.
Analysts say it is vital to get the bond auctions functioning. There is now a 205 billion net liquidity shortage sterilized overnight.
The US Federal Reserve is also firing a global commodity boom by purchasing bonds in a so-called Powell Bubble. In 1951 however Fed Governor Marriner Eccles ended a bubble famously getting independence for the Treasury and saving the Bretton Woods system of soft-pegs from an early collapse.
“You only protect the public credit by maintaining confidence in the Government and in its securities and to the extent the public will buy and hold those securities,” Eccles said in 1951.
“The thing we are doing is to make it possible for the public to convert Government securities into money and to expand the money supply of this country by $7 billion in six months.
“We are almost solely responsible for this inflation…the whole question of having rationing and price controls is due to the fact that we have this monetary inflation, and this Committee is the only agency in existence that can curb and stop the growth of money.”
On September 01 authorities said sugar stocks of five private firms were seized for ‘hoarding’ and will be sold under price control to consumers.
Similar claims had been made in the 1970s when price controls created shortages when the central bank was the main buyer of government bonds leading to a ‘controlled economy’. (Colombo/Sept02/2021)