Inflows, Only Way To Curb Rupee Fall
By Paneetha Ameresekere
The exchange rate (ER) marginally strengthened to the Rs. 131.20/131.60 levels to the US dollar ($) in two way quotes on thin volumes in spot, interbank trading on Friday (June 15), compared to the previous day’s close at the Rs. 132.00/132.30 levels, which a market source told this reporter was no cause for a jubilation.
Week on week the ER has however weakened by Rs. 1.20/Rs.1.10 in two way quotes.
“The rupee gaining by a couple of cents against the greenback (in this instance by 70 Sri Lanka cents in spot sales) on Friday over that of the previous day’s close doesn’t mean a thing, he said. This is in the usual run of business, the source said. “It has not been caused due to a flurry by exporters, rushing to encash their $ proceeds,” he said.
On Thursday, the ER held on to the same levels it commanded the previous day Wednesday (June 13), with it being quoted at the Rs. 132.00/132.30 levels to the$ in two way quotes, again on thin volumes in spot, interbank trading.
“Volumes were thin on Thursday, around $ 10-15 million, compared to the previous day’s figure of around $ 70 million,” the source said. Exporters are encashing a minimum amount of $s, sufficient to meet their daily needs, but not sufficient to strengthen the ER, he added. Recently state owned Central Bank of Sri Lanka’s (CBSL’s) Director Economic Research Mrs. S. Gunaratna was quoted to have had said to a foreign news agency that the ER will settle at the Rs. 132 level, a statement which was however denied by CBSL the following day, which insisted that the ER should settle at the Rs. 125 level or below, a stance it has taken in recent times (see also this publication’s last week’s business editorial).
“Neither CBSL Governor Ajith Nivard Cabral, nor Treasury Secretary Dr. P. B. Jayasundera nor President Mahinda Rajapaksa saying that the ER should strengthen to the Rs. 125 level or below will work, but substantial inflows will help this to happen,” the source however said.
Inflows mean either enhanced foreign direct investments-FDI (or even foreign investments into the stockmarket) , or exports or remittances or grant aid, or tourism receipts or a mix of cumulative incomes from either two or more of these sectors, neither of which (or together) however are greater than import demand and other related external payment commitments such as the servicing of foreign debt which the Government of Sri Lanka (GoSL) has to make, has resulted in pressure being brought about on the island’s balance of payments (BoP) position currently (See also last week’s business editorial).
Meanwhile the ER which opened at the Rs. 132.50/132.75 levels to the $ in two way quotes in spot, interbank trading on Wednesday (June 13), strengthened to the Rs. 131.50 level due to the receipt of inflows, before weakening to the Rs. 132 level because of the advent of buying pressure on the greenback.
State intervention was missing from the market on Wednesday as well as on the following day Thursday, the source said. “It’s the confidence factor that is not there in the market that tends the ER to fall from one low to another,” he said. Exporters are encashing their $s, but very sparingly, according to their needs, not sufficient to strengthen the ER though,” the source further said.
No amount of curbs or restrictions as currently have had been imposed, will help to rein in the ER either, as present events have had proven, he added.
Meanwhile the ER fell to a historic low of Rs. 133.50 to the $ at Tuesday’s (June 12) trading, resulting in the GoSL/ CBSL using its agent, state controlled People’s Bank to offer $s to the market at Rs. 133.50 in spot, interbank trading to prevent its further fall, the source said.
“People’s Bank was also there at the Rs. 132 level (resulting in the ER strengthening as a consequence on Tuesday), before withdrawing, after which the ER once more weakened to close the day at Rs. 132.50/133.00 level in two way quotes,” he said.
In a scenario where inflows have had virtually dried up, what is now needed to shore up the local currency is intervention in small doses such as what is happening now, he said. Previously CBSL/GoSL adopted a rigid stance by defending the ER which resulted in the frittering away of the island’s foreign exchange (forex) reserves.
The source further said that at the beginning of last week on Monday (June 11), the ER weakened by as much as Rs. 1.50 in a day on thin volumes, as low as $ 10 million in interbank trading, to be quoted at Rs. 131.50/132.00 to the $, compared to the previous market day-Friday, June 8’s two way quote figure of Rs. 130.00/130.50 at closing.
When this reporter asked Dr. John Nelmes, IMF’s team leader for Sri Lanka at a press conference on Friday as to whether he sees the ER stabilizing on account of various policy actions taken by GoSL, he said that prior to joining the IMF he was employed by the Bank of Canada. It was their job then to predict the movement of the $ vis-à-vis the Canadian dollar.
“But we knew that when we made such predictions, more often than not we would end up being wrong,” he said. Nelmes however said that due to those policy actions taken by GoSL, they see macroeconomic stability taking place in the economy, with imports contracting, relieving stress on Sri Lanka’s BOP position as well as on its current account.
Those policy actions include raising CBSL’s policy rates, resorting to a flexible ER, increasing electricity and fuel prices, increasing vehicle import taxes, coupled with jacking up the administered prices of bread, milkpowder, bus fares, gas and cement.
Nelmes said that they were cognizant of the social and economic impact such policy changes have had, but such decisions were needed for macro economic stability and infrastructure development that would help to take Sri Lanka forward. A small, trade dependent and an open economy such as Sri Lanka is susceptible to those “shocks” associated with a flexible ER regime, he however said. On the issue of the release of IMF’s last tranche of some $ 426.8 million in its $ 2.5-2.6 billion standby arrangement with the GoSL (see also the business pages of The Sunday Leader issue of 8.4.12.) and for which prime purpose the IMF team made their visit here, Nelmes said that the decision in this connection rests with their Board which will take up the issue next month (July).
“However we see positive effects taking place in the economy due to recent policy actions taken by GoSL,” he said. “We are waiting for certain June numbers in relation to those pertaining to forex reserves, things monetary and the direction of the budget, of which the officials have told us that the targets are on track,” said Nelmes.
He said that the authorities aimed for a budget deficit to be equivalent to 6.2% of GDP. Nelmes further said that they are talking of a new facility with the GoSL, further details of which will be discussed when an IMF team arrives in Colombo in September. He also said that due to the policy measures taken, imports have had contracted, which has had a ripple effect on revenue, with a lowering of collections.
But the authorities have assured that the fiscal targets are on track. He predicted that Sri Lanka would grow by 6¾% this year, lower than the CBSL’s target of 7.2%. Nelmes further said that that they had also witnessed stresses in banks’ non performing loans (NPLs) due to the prevailing high interest rate regime compounded by the high credit growth in the past two years. “But this stress is manageable,” Nelmes said. “We see the banks well capitalized and liquid.” He expected the year to end with an inflation figure of 9½%, brought about by the actions of high energy prizes and a depressed ER. On the issue of FDI, Nelmes said that a low inflationary regime and macroeconomic stability were sine qua non to attract such, and the country was moving in that direction.
He further said that a further tightening of policy rates might be needed in order to bridle inflation.
On the question of retail energy prices and the shift towards an automatic pricing regime, he said that the current policy actions, backed by falling oil prices were bringing dividends to the loss making Ceylon Petroleum Corporation and CEB, which losses would come down to about¾% of GDP this year. He was however cognisation of the role played by the weather in Sri Lanka’s energy play, where good rains meant less dependency on imported fossil fuels and more reliance on the cheaper hydro power.
Nelmes further said that the euro zone crisis may have a negative impact on the island’s exports, its largest export market. Meanwhile in money markets, those continued to remain short, a carry over from the beginning of last week, Monday, due to demand, where the market was short by Rs. 300 million on that day, and which increased by more than five fold to Rs. 1,559 million the following day Tuesday; and continued in the same vein on Wednesday, recording a Rs. 1,400 million shortfall, where those shortfalls were met by CBSL’s reverse repo window.
On Thursday, CBSL, after a lapse of three months held a reverse repo auction to deal with market liquidity shortfall, selling Rs. 1,000 million to the market at a weighted average yield (WAY) of 9.50%, 25 basis points (bps) less than its reverse repo rate of 9.75%.
While on Friday, the shortfall in the market was increased to Rs. two billion, with this being snapped on that day’s reverse repo auction at 9.52%, two bps more than the previous day’s WAY.
This liquidity shortage is causing further pressure on rates, resulting in the weighted average rate of call money transactions since last Friday to go up from 9.99% to 10.28%, a 29 bp increase in the space of two market days, ie up to Tuesday, while it increased by a further 25 bps to record a figure of 10.53% by Wednesday and by another five bps to 10.58% the following day Thursday (June 14), before declining marginally by two bps to 10.56% on Friday.
Generally ERs and interest rates move in opposite directions, ie when the ER weakens interest rates fall due to a contraction in demand for forex ($s) as the latter has become too expensive, while when the ER strengthens, interest rates rise due to an increase in demand, as buying $s have had become cheap, with the increase in demand for rupees to buy $s causing a rate hike. However in this instance, whilst the ER is falling, interest rates have had been rising and not vice versa, thereby going against market fundamentals.
“This is because both of these indicators have had been suppressed for so long and were not allowed to take their natural course as per the supply-demand law by GoSL/CBSL,” the source said. Previously, as an example of this protectionist mode adopted by the state, from the second half of last year and up to the presentation of Budget 2012 in November, CBSL has had been protecting the ER despite pressure for it to weaken due to demand.
Similarly, during this period, despite high credit demand (credit to the private sector grew by 34.5% year on year last year), CBSL refused to increase its policy rates (an indication that market interest rates too should go up) to curb demand. As a result of artificially restraining such market forces to act for so long, without allowing them to take their natural course, but only now allowing those to be unleashed, they are therefore first smoothening the earlier distortions (like what is now happening) because of previous artificial curbs, before allowing market fundamentals to takeover its play. Meanwhile Wednesday’s weekly Treasury (T) Bill auction saw the weighted average yields (WAYs) of T Bills of 91, 182 and 364 day tenures going up by nine, 17 and one basis point each respectively, as the illiquid state of the market percolated down to the T Bill auction as well, tending these WAYs also to rise.