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Sri Lanka secondary bond yields rise as monetary policy tightens

ECONOMYNEXT – Sri Lanka’s bond yields have risen about 100 basis points over the last two weeks since the Central Bank stopped large scale money printing and started to withdraw some liquidity in monetary tightening moves, market data shows.

The three month Treasuries auction yield has gone up 22 basis points to 6.28 percent from 6.06 percent, the 6-month yield has risen 24 basis points to 6.54 percent from 6.30 percent and the 12-month yield has risen 15 basis points to 7.01 percent from 6.86 percent.

Large Scale Monetization

Up to December the central bank was monetizing hundreds of billions of rupees in quantity easing moves generating long term liquidity outside the overnight open market operations putting the rupee under pressure and generating balance of payments trouble.

By the beginning of December the Central Bank’s Treasury bill stock, a proxy for money printing and forex reserve appropriations was at 220 billion rupees.

Even if policy rates are not hiked, once excess liquidity runs out of the banking system, the Central Bank should have injected cash at 7.50 percent ceiling overnight rate or above the mid-point of the policy corridor through open market auctions instead of buying bills at around 6.0 percent, analysts say.

By purchasing Treasury bills with printed money, the central bank kept the three month rate near the 6.00 percent overnight window injecting liquidity ‘quantity easing style, generating balance of payments pressure and engineering a collapse of the currency in the process.

Data released later on Friday will show whether more rupee were printed at Wednesday’s Treasuries auction.

Falling through the floor

This year the Central Bank also lost control of the overnight gilt-backed fell through the Central Bank’s 6.0 percent overnight floor rate on several occasions amid massive excess liquidity and monetization.

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Sri Lanka’s central bank no longer gives securities when it withdraws liquidity.

As a result market participants preferred to do repos with counterparties who gave them bills to pass on to clients at a rate below the floor window rate.

"On monetary policy, we are on the tightening side,” Deputy Governor Nandalal Weerasinghe said Thurday.

"Market rates are going up. In future, we are ready to take whatever policy measures are needed – if monetary policy needs to be tightened."

However over the last two weeks the Central Bank has effectively tightened monetary policy by withdrawing liquidity through outright securities sales, term and overnight auctions, central bank watchers say.

On Thursday overnight excess cash was sterilized at 6.09 percent, near the 3-month bill yield two weeks ago.

There was still 66 billion rupees of excess liquidity in interbank markets by Thursday, though lower than the 138 billion rupees seen on December 01. Overnight repos were quoted around 6.25 percent, Friday morning.

Bonds Soar

In the bond markets Friday there were hardly any quotes as the market looked for direction with a bond auction results due later in the day. Only a few maturities were quoted.

A 2-year bond maturing on 15.07.2017 closed at 7.80/8.20 on Thursday up from 7.35/7.50 percent on December 08.

A 5-year bond maturing 01.05.2020 closed 9.20/60 yesterday up from 8.85/95 two weeks ago.

8-year bond maturing on 01.09.2023 quoted at 10.00/50 Friday up from 9.25/50 percent two weeks ago. The 8-year was one of few bonds that were quoted.

10-year bond maturing on 01.08.2025 closed at yesterday at 10.40/10.60 percent up from 9.35/60 percent two weeks ago.

20-year bond maturing on 15.03.2035 quoted at 11.00/11.40 up from 10.10/25 percent two weeks ago. (Colombo/Dec18/2015)

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