ECONOMYNEXT – Sri Lanka’s rupee has free floated at least for two days, analysts said with no central bank intervention or moral suasion and rates also moved up in a Treasury bill auction with no observed money printing to suppress interest rates, analysts and dealers said.
The rupee weakened as much as 155.90 on Wednesday, amid political turmoil after the shock defeat of the ruling coalition at a local council poll, but bounced back to close at 155.35/45 to the US dollar in the spot market.
There was heavy dollar purchases by importers but exporters sold dollar later in the day, helping the rupee recover, dealer said.
There was no moral suasion or intervention by the central bank, dealers said.
In an important development the central bank also did not intervene in Treasury bill auctions with printed money Wednesday, a move that generally leads to balance of payments crises and rapid weakening of the rupee.
The 12-month yield rose 34 basis points to 9.28 percent, the 6-month yield rose 30 basis points to 8.29 percent and the 3-month yield rose 27 basis points to 8.02 percent in line with the movement seen in longer term bonds.
The bank accepted the advertised 28.4 billion rupees of bills at the auction, indicating that no money was printed to generate balance of payments pressure.
The central bank’s principle tool of creating balance of payments crises is to reject bids at bill auctions and buy Treasury bills with printed money in a quantity easing style move, EN’s economic columnist Bellwether says.
By rejecting bids and purchasing Treasury bills with printed money the central bank expands reserves money, creates excess liquidity in money markets and pushes up demand for dollars as the money is spent, causing the currency to weaken.
By accepting real bids, the balance between rupees and dollars remains.
Money markets now have excess liquidity of about 20 billion rupees, which could turn into import demand as they are loaned out.
The liquidity was created by dollar purchases by the central bank. The rupees created has been sterilized by selling down the central bank’s treasury bill stock and lately through term repo auctions, putting upward pressure on the rupee.
However the central bank has been intervening in forex markets and steadily buying dollars and increasingly higher rates steadily weakening the rupee over the past year, despite sterilizing the purchases in a bid to give profits to export firms.
When the rupee weakens exporters get profits because salaries do not go up with the inflation generated. Analysts had warned that such the inflationist-devaluationist would lead to political instability as inflation goes up.
In Sri Lanka, unlike in countries like Singapore energy prices are also not market priced frequently and losses in state energy entities -which may be funded with credit widen margins.
A central bank that intervenes and sterilizes dollar purchases or sales, does not allow a currency to float. A prolonged sterilization of dollars sales by purchasing Treasury bills with printed money to keep rates down, will generate a balance of payments deficit.
That is why if a central bank that targets interests, through open market operations of its domestic operations department will create massive pressure on a currency, and then blames forex dealers for ‘speculating’ with the additional money created.
Sri Lanka’s central bank does not seem to be doing that – yet. (Colombo/Feb15/2018)