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Sri Lanka rupee steady with intervention, pressure from capital outflows

COLOMBO (EconomyNext) – Sri Lanka’s rupee traded steady at 134.00 to the US dollar in the spot market with dollar sales by state banks, dealers said, as capital outflows also gathered pace and interbank liquidity dropped further.

In the forward market, one week dollars were restricted at 134.15, one month at 134.70 and three month dollars at 135.85 to the rupee by moral suasion, dealers said.

In the interbank market liquidity has been dropping steadily from 97 billion rupees on June 01 to 70 billion rupees on June 16.

Foreign holders of rupee bond holders have started to sell down their holdings steadily since mid-May, with their holdings down to 440 billion rupees by last Friday, from 457 billion on May 06.

Meanwhile the Central Bank’s Treasury bill stock also rose from 5.4 billion rupees to 23 billion rupees, which is usually indicative of a reserve appropriations to settle state foreign loans when excess liquidity remains.

With liquidity dropping rapidly, the monetary authority may soon have to actively start sterilizing foreign exchange sales by printing fresh money, analysts say.

Sri Lanka has a soft-pegged Central Bank which tries to control both the interest rate and exchange rate and generates balance of payments crises frequently.

The problem first starts in the current account, triggered by a sharp rise in state credit which is not accompanied by a similar rise in interest rates. As the credibility of the dollar peg weakens, the problem spreads to the capital account or financial account of the balance of payments.

Analysts have warned that Sri Lanka was heading for rouble with ultra-low interest rates even before a January 29 revised budget delivered a further shock to the credit system.

In addition to the usual tools the central bank uses to precipitate a balance of payments crisis, this time a large volume of liquidity, amounting to more than half the official base money was kept temporarily sterilized despite warnings the accompanying reserves were in danger.

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Analysts had warned that with Sri Lanka’s high exposure to international markets, that the elected ruling class would not be not be able to take fiscal risks, that the they had taken in the past.

The current BOP episode is also distinctive in that it was supported with comments from the International Monetary Fund, which denied that there was balance of payments pressure, on the basis of lower oil prices, earlier in 2015 even after retail fuel tariffs were cut.

Falling or rising oil prices are neutral on the balance of payments if retail prices are adjusted in line.

Rising oil prices hurt the balance of payments only if prices are not raised, leaving disposable income in the hands of people to spend on non-oil imports.

The opposite happens when oil prices fall. But if retail prices are cut, there is no advantage as disposable income available in the hands of market participants within the country, go up.

However if credit picks up, even savings made by oil distributors will come back to the economy through the banking system and any net pressure on the currency comes from Central Bank releases of liquidity.