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Friday January 21st, 2022
Bonds & Forex

Sri Lanka slaps price controls on forex swaps despite tight dollar liquidity

ECONOMYNEXT – Sri Lanka has placed a ceiling rate on interbank foreign exchange swaps despite there being no dollar liquidity window for banks in a severe liquidity crunch, in the latest control slapped on financial markets hit by forex shortages from liquidity injections.

Sri Lanka banks face severe dollar funding crunches either after paying for essential import bills ending up with a negative net open exposure or buying dollar denominated assets like Sri Lanka Development Bonds.

With credit downgrades hitting funding lines, banks borrowed dollars at rates as much as 50 percent to cover themselves in recent weeks.

“Considering recent excessive volatility observed in the USD/LKR domestic swap market, and to ensure orderly conduct of the same, licensed banks are hereby instructed to execute USD/LKR swap transactions, subject to a maximum USD interest rate of 10 per cent per annum,” the central bank said in a direction issued on

“Accordingly, the USD/LKR swap points shall be prorated based on the above benchmark USD interest rate for the respective tenors until further notice.”

Banks will now have to be even more cautious in paying for import bills and rolling over Sri Lanka Development Bonds, market participants said.

A state bank in particular is in severe dollar crunch for funding purposes.

The central bank claimed powers under the Monetary Law Act in slapping the price control which market participants say effectively cuts off the final dollar funding line to banks.

Separately price controls were also placed on dollar deposits.

Sri Lanka interbank dollar funding costs shoot towards 50-pct

Sri Lanka central bank controls dollar deposit rates amid currency crisis

However there is no dollar liquidity window for banks to cover funding gaps.

Sri Lanka’s dollar yields have risen sharply as liquidity tightened after downgrades and counterparty risks rose.

Sri Lanka is currently facing a currency crisis due to low interest rates enforced with liquidity injections.

During the ousted ‘Yahapalana’ administration when the currency collapsed from 131 to 181 in two crises, deposit rate controls were slapped on rupee deposits of hapless savers after printing money to bust the currency peg and drive inflation up.

The rupee is now on a 200 to the US dollar peg which has lost credibility and parallel exchange rates are around 250 to the dollar.

In 1950 a classical analyst writing in the London-based The Banker magazine warned of things to come when a money printing central bank with was set up with other sweeping powers.

“It will be obvious from this summary that the new Monetary Board is going to be given almost unlimited power of control over the banking system of Ceylon-a power which, if misused, could do irreparable harm to the island’s economy,” the analyst wrote.

“The experience of the next few years will be watched with inter~st to see whether the Ceylon experiment will indeed show the rest of the Empire the way that a developing economy should take to free itself from the as yet ungauged disadvantages of the Currency Board system or whether it will merely provide another example of the tangled skein so often woven by those who set out with the good intention of making finance ” the servant instead of the master of the people “.

Already the dollar forward market had been killed for bank customers and a series of foreign exchange controls are in place. (Colombo/Jan02/2021)

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