Sri Lanka rupee falls in early trade, overnight rates higher

ECONOMYNEXT – Sri Lanka’s rupee was quoted at 166.50/80 to the US dollar in the spot market in mid-morning trade Wednesday down from yesterday’s close of 165.90/166.10 as the central bank announced more cash injection through term reverse repo auctions.

Overnight repo rates were around 8.20/30 percent levels, dealers saif with 15 billion rupee borrowed from the window at 8.5 percent. Higher overnight rates and a net liquidity shortage will support the rupee, analysts say.

Bond yields were also higher.

Sri Lanka’s money markets faced a severe cash shortage this week coinciding with a 750 million dollar bond repayment by the National Savings Bank, which had swaps with the central bank.

The NSB had borrowed a total of a billion US dollars from bonds with 750 million dollars maturing on September 18.

NSB had had said it reduced forex risks by engaging in a swap with the central bank, buying government dollar bonds and lending to state owned enterprises in dollars. NSB had a 183.435 million dollar swap renewing annually and a 187.5 million renewing monthly.

Transaction with the central bank, unlike normal market participants lead to changes in base money and disruptions in the credit system.

A reversal of a currency swap with the central bank (unlike a normal bank) leads to a contraction in reserve money and a liquidity shortage in the money market.

A reversal of a swap is also similar to pegging (‘selling’ central bank dollars to stop a steep fall in the currency) and runs directly contrary to a floating exchange rate.

A current run on the rupee came from a liquidity created from currency swaps which expanded reserve money and excess liquidity in the style of an unsterilized purchase of dollars, according to central bank watchers.

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However the currency was not defended through unsterilized sales, in an inconsistent policy, when the new money turned into imports, leading to a run on the rupee, EN’s economic columnist Bellwether says.

Sri Lanka’s central bank has been juggling with a peg and also claiming to operate a ‘flexible exchange rate’ the exact meaning of which is unclear but in practice it has turned out to be an intermediate (neither floating nor fixed) regime with inconsistent policy that has led to severe disruptions in the forex market and permanent depreciation of the currency.

To avoid disruptions to the monetary base (reserve pass through transactions) any remaining swaps with the central bank should be settled with Treasury bills, through back to back transactions, especially if there was no excess liquidity in the in the market, Bellwether says.

On Tuesday banks borrowed 15 billion rupees at 8.50 percent though the overnight window, with the central bank offering only 15 billion rupees through an overnight reverse repo auction after a 38 billion rupee liquidity shortage emerged.

Another 5 billion rupees was injected at 8.07 percent, below the ceiling policy rate of 8.5 percent, effectively sterilizing the liquidity shortage.

Analysts say the ceiling policy rate of 8.5 percent and keeping money markets on a tight leash until credibility is restored is the best defence the country has against further currency depreciation.

On Wednesday the central bank announced another 20 billion rupee overnight auction and 10 billion for six days. It is not clear whether today’s auctions will end the liquidity shortage and put further pressure on the rupee. (Colombo/Sept19/2018)

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