Sri Lanka’s soft-pegged rupee struggles as Hong Kong, Gulf central banks keep stable currencies

ECONOMYNEXT – Hong Kong’s currency board raised its base rate to keep its hard peg intact after the US Fed raised its policy rate, and several Middle Eastern monetary authorities with stable currencies also raised rates while Sri Lanka’s rupee struggles with a contradictory soft-peg.

The Hong Kong Monetary Authority, which has a credible, or hard, peg with a floating policy (linked exchange rate system) raised its base rate by 25 basis points to 2.25 percent. 

Liquidity is actually provided by a formula linked to overnight and one month offered rate, that automatically rises if there are capital outflows or speculation. This prevents full sterilization and stops the exchange rate falling.

The credible peg has been fixed at 7.8 to the US dollar since 1983, and it didn’t fall during the Asian Financial Crisis, and is usually ignored by the popular press for being ‘boring’.

The UAE, another financial center with a highly credible peg, said it was raising its repo rate (reverse repo in Sri Lanka) and certificates of deposits (repo) by 25 basis points. The UAE Dirham had remained fixed at 3.675 to the US dollar.

Saudi Arabia raised its overnight corridor by 25 basis points to 2.25 and 2.75 percent.

Kuwait which also had a rate of 3.0 percent said it was not changing the rate as credit growth was weak.

The Central Bank of Bahrain said it was raising its overnight rate by 25 basis points to 2.25 percent, and the one month term rate corridor to 3.25 and 4.25 percent.

Sri Lanka’s rupee has collapsed from 153 to 169 to the US dollar so far this year.

Due to inconsistent policy, Sri Lanka’s central bank has been unable to hold the peg even with a policy corridor of 8.0 and 8.5 percent.

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Sri Lanka’s central bank has followed prudent policy keeping overnight cash short for eight days since pressure on the currency began building up earlier this month.

But it is still injecting cash below the ceiling rate after generating pressure on the soft peg with excess liquidity in July and August.

At the moment the central bank has injected a total of 123 billion rupees through overnight and term auctions to sterilize interventions (about 730 million US dollars at current rates).

A large liquidity short developed earlier in the month, coinciding with a foreign loan maturity at a state bank.

The Sri Lanka rupee was quoted at 169.10/40 to the US dollar in early trade Friday, strenthening from 169.25/55 levels late Thursday.

Countries that have permanently depreciating currencies tend to have high nominal interest rates. (Colombo/Sept28/2018)
 

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