Rupee Plummets 3.1% In A Week

• Market Badly Needs Inflows To Relieve Pressure on ER

Without US dollar ($) inflows it will be difficult for us to survive,” a banker referring to the steep decline in the rupee due to the market’s insatiable appetite for the greenback,  told this reporter on Wednesday (see also the business page lead story of this newspaper’s 26.2.12. edition).
But inflows are not coming in as fast as they were expected after the war end.
Various reasons have been attributed to this state of affairs such as the Government’s recently passed Expropriations Act which may scare investors, coupled with the economic crisis in the West.
“Essentials like medicine imports and not necessarily luxury imports are causing the rising demand for $s in the market, hence the reason for it to become dearer by the day,” he said.
A stable exchange rate (ER) and low interest rate and inflationary regimes are needed to attract foreign investments into the economy, another banker said. In this score, he found fault with President Mahinda Rajapaksa’s Expropriations Act passed in November of last year, which he said would scare, rather than attract foreign investments into the country.
The source further said that at the rate importer pressure is bearing on the ER, it may well end the year at the Rs. 130 levels, thereby debunking the lead story on the business pages of this newspaper’s last week’s edition, which said that the ER will settle at the Rs. 120 levels, provided no sanctions are imposed by Geneva on Colombo due to alleged human rights abuse during the closing stages of its war against the LTTE and/or the possibility of oil prices going through the roof in the event USA/Israel attacked Iran over its nuclear programme.
But without either of those taking place, at least upto now, the ER anyway is under continuous importer pressure, with the exception being on Friday, where it gained by 40 cents in spot interbank trading to be fetching prices of Rs. 125/125/30 in two way quotes, compared to prices of Rs. 125/60/70 at the previous day’s close.
Except for Friday’s brief respite, during the rest of last week however, the ER has been on a continuous decline. From last Friday (March 9) to Thursday (March 15) it had declined by 3.5% to pick up slightly by 0.3% at the weekend over that of Thursday’s close.
However that may be, the ER, in the one week period ended on Friday had declined by 3.1% (Rs. 3.80) in value and since the beginning of the year by 10% (Rs.11.40).  After CBSL withdrew defending the rupee on February 9 (due to pressure on its foreign exchange reserves), the ER has declined by 9.6% (Rs. 11). And from the time President Mahinda Rajapaksa announced a 3% rupee devaluation when presenting Budget 2012 in Parliament on November 21 of last year, the ER to date has depreciated by 13.5% (Rs. 14.90).
Meanwhile the trade deficit last year widened to $ 10 billion, while Sri Lanka’s oil import bill last year surged 53% year on year to $ 4.6 billion, according to CBSL data.
Meanwhile on Thursday the ER held on to the previous day Wednesday’s position. But on Wednesday it declined by Rs. 1.15 to Rs. 124/90 over that of the previous day Tuesday’s close. On Tuesday (March 13), the ER weakened by Rs. 1.70 to Rs. 123.50 to the $ in interbank trading over that of Monday’s close. Meanwhile the rupee, due to a mix of importer pressure, coupled with the Government allegedly having to settle oil bills, weakened by 50 cents, resulting in the  ER falling to Rs. 122 to the $ at Monday’s (March 12) spot, interbank trading, over that of the previous day Friday’s (March 9) close.
The source said that the best prescription that the Government of Sri Lanka (GoSL)/ Central Bank of Sri Lanka (CBSL) should have had followed earlier was to have had allegedly listened to the advise given by the IMF around the middle of last year, ie by allowing the rupee to float from that time onwards and not later.
Is it only now, that in the foreign exchange (forex) market, the authorities are trying to do, what the IMF prescribed then;  a case of “too little too late..?”
A source also said that a number of exporters, even prior to the Budget 2012 rupee devaluation, had made forward bookings of their $ proceeds, even extending it up to a year, on the belief that the rupee won’t be devalued, on the strength of what CBSL Governor Ajith Nivard Cabraal had said then, and even continuing up to the free float, ie after the 3% Budgetary devaluation, where Cabraal at that point of time had continued to maintain that the rupee will not be devalued further. Then came the February 9 bombshell of the rupee being allowed to free float.
They, the exporters, due to their previous forward bookings at low premia, have therefore taken a hit, he said.
Meanwhile, CBSL recently cutting down on banks’ net overnight $ open positions to a third, coupled with exporters holding on to their $s with the expectation that the ER would weaken further and importers’ clamouring for $s to make their purchases, added further pressure on the ER, another source said.
Due to banks’ individual limit issues vis-à-vis $ lending, that too has caused pressure on the ER, he said.
“When the ER went down to Rs. 123 recently, Cabraal is reported to have had said that that was due to bank speculation. Then CBSL cut down banks’ net open positions as a measure to cut down this so called speculation, the ER temporarily strengthened from Rs. 122 to Rs. 120, before again going down the precipice. Now what has Cabraal got to say?” a source asked.
It’s the “demand and supply” factor in economics that is determining the value of the ER and not speculation, he contended.
The object of CBSL reducing banks’ net open $ positions by a third recently was to ward off speculation in a scenario where there was pressure for the ER to weaken after its last month’s free float, he said; but what is now happening is banks which are on the borderline of meeting their open positions, by preferring caution over aggression, that has had the net effect of causing further pressure on the ER, a situation which CBSL in fact had wanted to avoid, but then the opposite is taking place due to CBSL’s actions,  a source said.
Meanwhile the $’s one year forward premiums  on bank swaps fetched a price of Rs. 9, ie equivalent to the difference between the yields of one year Treasury (T) Bills and the yields fetched by US Treasuries of a similar tenure, on Monday (March 12).
“That is how it should be, but the difference here is that local T Bill yields are continuously rising,” he said.
And rise they did at Wednesday’s T Bill auction, with the weighted average yields (WAYs) of 91, 182 and 364 day T Bills increasing by  31, 28 and 31 basis points (bps) to 10.42%, 10.46% and 10.76% respectively, despite the fact that the Government says that inflation is falling.
If inflation is actually falling, then T Bill yields should also fall, but the opposite is taking place, a source said. CBSL at Wednesday’s monthly Monetary Policy announcement kept policy rates unchanged, but the source predicted that at the next monthly monetary policy statement release due on April 18, CBSL would jack up policy rates by 50 bps.
Increasing policy rates is a two edged sword, in that it makes borrowings more expensive, therewith easing pressure on borrowings, made for the purpose of buying  forex for the making of imports, thereby easing pressure on the ER. A high interest regime will also encourage people to save, therewith easing the illiquid state in the market, which in turn would also ease pressure on rates.
Increasing policy rates also have a complementary effect on market interest rates.
He further said that at the time CBSL was defending the ER, one year forward booking premium was in the region of Rs. 2.50; but now it has gone up to Rs. 9 in tandem with the interest rate differential between one year T Bill yields and that of one year US Treasuries.
But as exporters and importers are now debarred by CBSL from making forward bookings exceeding 90 days as a tool to ease stress on the ER, which value has been diminishing rapidly since its free float on February 9, forward bookings exceeding 90 days are now made by banks engaging in $ swaps.
He however said that that exporters who booked forward the ER at the Rs. 111-112 levels prior to the rupee devaluation which President Mahinda Rajapaksa announced when presenting Budget 2012 in Parliament on November 21 of last year, have had made significant losses with the ER now trading at the Rs. 120 level or even below.
Meanwhile a rise in T Bill yields also makes Government borrowings expensive. Further, T Bill yields are also used as a yardstick to decide which way market interest rates should go. The higher T Bill yields fetch, the higher market interest rates will also rise, in tandem with such increases, therewith stultifying investments because of higher borrowing costs, putting the brakes on employment creation as a result.
Rise in T Bill yields are also caused by a liquidity crisis facing the economy, not least caused by import demand, coupled with the GoSL/state owned Ceylon Petroleum Corporation (CPC) having to settle purchases made on imported oil.
And in the back of a tight liquidity crunch in the market, call money rates, ie interbank borrowings for a day, crossed the 10% mark last Friday (March 9), giving negative signals on the economy, of the possible return of a higher interest rate regime, with all of its attendant evils, such as making borrowing costs more expensive, therewith stultifying investments in the economy.
As a result, CBSL, as a damage control measure, has been asking banks not to allow interbank borrowing rates to go beyond 10%. Seemingly as a consequence, average call money market rates had come down to 9.78% by Tuesday (March 13), from 10.1% two market days ago, ie on Friday March 9. It was 9.69% on Wednesday.
With the US led embargo on Iran for its alleged nuclear programme, that closes a door for Sri Lanka to buy oil from its hitherto main crude oil supplier, namely, also Iran, and with it, the comfort of its credit line ending, therewith forcing GoSL/CPC to pay spot cash for its oil purchases, this however causes pressure on the ER as a result.
Currently $ forward bookings are being mainly made by banks, in order to make rupee swaps against their $ holdings, by taking advantage of the liquidity crisis currently facing the market, he said.
Sri Lanka urgently needs massive amounts of foreign inflows to tide over the situation, the source said. This will also relieve pressure on the liquidity crisis facing the money market, already, CBSL’s T Bill holdings has gone pass the Rs. 250 billion mark, he said. By Wednesday it had come down to Rs. 245 billion however.
CBSL prints money and in lieu subscribes to T bills, that is one of the key mechanisms used by CBSL to flood the market with rupee liquidity when foreign inflows are at a standstill or have been reduced to a trickle. But the danger in this type of excessive operations, it causes inflationary pressure on the economy, ie a rise in prices, hurting the poor, the vulnerable and the fixed wage earner the hardest (See also page 42).

Limits Imposed
Central Bank of Sri Lanka (CBSL) limiting banks parking their excess liquidity in its overnight repo window to Rs. 100 million per bank from last week as a measure to ease pressure on rates not only helped interbank borrowing rates which hit a high of 10% the previous week to marginally come down, but also created activity in the short term Treasury (T) Bill secondary market, a source told this newspaper.
These limits become applicable only in the event CBSL holds a reverse repo auction on a particular day to meet a market shortfall.
“There was demand in the secondary T Bill market for tenures of three months and below as a result of this, but yields held because there was an equal amount of supply to match demand,” he said.
Banks which have lending limit issues with peer banks were therefore forced to park their excess liquidity in T Bills as a precaution, hence the reason for activity in the short term T Bill market. CBSL last held a reverse repo auction on Monday (March 12).
T Bill yields of three month’s (91 day) tenure at last week’s weekly auction rose by 31 basis points to 10.42%.