State Abandons Rupee In Its Lust For $s

The rupee virtually crossed the Rubicon at Friday’s (June 22) trading, with the exchange rate (ER) going below the Rs. 133 level, and for the first time the state not making an effort to shore it up.
The ER was being quoted at the Rs. 133.10/133.70 level to the US dollar ($) in spot, interbank trading at the weekend, having had weakened by Rs. 0.40/0.80 over that of the previous day’s close of Rs.132.70/132.90 in two way quotes.
On previous occasions, since its free float in February, the state intervened thrice, the first being in April, when the ER went below the Rs. 133 level, to shore up the rupee, but not this time.
President Mahinda Rajapaksa who is also the Finance Minister, coupled with Finance Ministry Secretary Dr. P. B. Jayasundera and state owned Central Bank of Sri Lanka (CBSL) Governor Ajith Nivard Cabraal have had previously being quoted to have had said that the ER should strengthen above the Rs. 125 mark, this was when the ER was flirting at the Rs. 133 level or below, but the market does not seem to have listened to the admonishments of those powerful voices.
The Opposition to the contrary has said that the ER will end at the Rs. 140 level.
“Despite the fact that volumes are thin,  coupled with various policy measures taken by the Government to curb imports, that has not assuaged the market’s thirst for $s,” a source told this reporter. He further said that the wide spread of 60 Sri Lanka cents between the “buy” quote and the “sell” quote witnessed on Friday was due to market volatility.
The ER, week on week has weakened by Rs. 1.90/Rs. 2.10 against the $, having had closed the previous Friday (June 15) at the Rs. 131.20/131.60 levels in two way quotes.  On the previous day Thursday, the ER continued with its downward spiral despite weakening import demand due to certain policy actions taken by the Government of Sri Lanka (GoSL), which saw the ER end at Rs. 132.70/132.90 to the $, having had weakened by Rs. 1.50/Rs.1.30 in two way quotes since last Friday (June 15) in spot, interbank trading, before falling further, the following day Friday.
Those policy actions by the GoSL included the raising of policy rates, capping credit growth to 18%-with an exception being made that a further 5% could be made from foreign exchange (forex or $) loans, liberalizing the ER, raising the administered prices of energy, milkfood, bread, cement and bus fares and increasing vehicle import taxes. In other developments, market’s excess rupee liquidity which swelled to Rs. 5.7 billion on Tuesday (after the market was short by Rs. one billion at the beginning of last week Monday), shrank by 85% in a day to Rs. 861 million by Wednesday, before climbing up to Rs. 2.4 billion the following day Thursday, CBSL data showed.
But on the following day Friday CBSL was compelled to have a reverse repo auction as the market was short on that day, where Rs. 1,000 million was sold to the market at a weighted average rate (WAR) of 9.58%.
“GoSL’s policy actions to curb pressure for the rupee to depreciate by making imports more expensive are working,” a source told this reporter on Thursday.
That also has had a knock on effect on the money market with pressure on rates to rise (the exception being Treasury (T) Bill yields, see below) not taking place as fast as one would have had expected due to the prevailing low liquidity levels in the market, he said.
Meanwhile at the beginning of last week on Monday the ER weakened to the Rs. 132.00/132.50 level over that of the previous market day’s (June 15) close of Rs. 131.70/131.90 in two way quotes.
The following day Tuesday it further weakened by Rs.0.70/0.35 to Rs. 132/70/85 to the $ in two way quotes over that of the previous day Monday’s (June 18) close on thin volumes on top of import pressure, though gaining marginally the following day Wednesday, a  source said.
On Wednesday the ER marginally strengthened to the Rs. 132.60/132.80 level in two way quotes, before slightly contracting to the Rs. 132.70/132.90 level the following day Thursday, but weakening the very next day Friday.
State intervention was however missing in the market.
“But In the past two months we have seen state intervention in the market when the ER has had hit a low Rs. 133 or below, we have seen this happening thrice since April, we may have to wait and see if this is repeated in the event the ER falls to the Rs. 133 levels or below in the coming days,” he said. But this was not to be as the aforesaid events have had proven.
Meanwhile the possible reason for Wednesday’s gigantic contraction in excess rupee liquidity in a space of 24 hours may be due to GoSL’s foreign debt servicing, where GoSL through its agents (generally the state run commercial banks) buys rupees from the market, which in turn they use up to buy $s from CBSL’s stock of forex reserves to meet such commitments, after paying CBSL in rupees (see also The Sunday Leader business pages of 10.6.12.).
Another reason could be the need to settle oil bills of the state run Ceylon Petroleum Corporation (CPC) for which purpose too a similar activity could take place, where CPC would have had bought $s, possibly at an administered price (ie lower than the market price) from CBSL.
In such an event, if however the seller of $s to CPC was the market, then the rupee liquidity would continue to remain within the system without diminishing,  but on the flip side this would cause pressure for the ER to decline further due to demand for  $s for such external payments.
An 18% cap on lending to the private sector for this year could be a constraining factor for this liquidity to be swallowed up by such, ie liquidity being bartered to fuel credit growth. In any case if such money was being locally circulated then it should return to the system generally by the following day, in this instance Thursday (June 21) the latest. Bank credit to the private sector grew by 34.5% last year, year on year.
In the money market, impacted by its illiquid state, caused by GoSL’s rising foreign debt servicing, coupled with inflationary pressure on the economy as a result of the knock on effects of a depreciated local currency and high fuel prices amongst others, saw the weighted average yields at Wednesday’s (June 20) weekly T Bill auction rise by nine, 18 and 11 basis points (bps) to 11.04%, 12.47% and 12.78% for tenures of 91, 182 and 364 days respectively.
With CBSL already burdened with a T Bill stock of over Rs. 200 billion, that gives it little space to intervene in the government securities market in order to stabilize such rates.
However that may be, the market on Tuesday (June 19) experienced a Rs. 5.7 billion surplus, after being continuously short since June 11. “The possible receipt of inflows may have had been the cause for it, as a result we may see call rates dip by about five bps at Wednesday’s (June 20) trading,” a source said. But that was not to be, with call money transactions’ WAR remaining unchanged at 10.61%, the same as that of the previous day Tuesday’s WAR, and as mentioned aforesaid, despite the market’s excess liquidity levels shrinking rapidly to a mere Rs. 861 million in value in a day by Wednesday.
But call rates on Thursday rose by four bps to 10.65%, before dipping marginally by one bp to 10.64% the following day Friday.
Meanwhile the WAR of overnight gilt edged T Bill backed market repurchase transactions contracted by one bp to 9.64% on Wednesday over that of the previous day’s close. But this gain was expected to have had been  short lived, considering the rapid diminishment of market liquidity the following day Wednesday. On Thursday market’s repurchase transactions increased by two bps to 9.66% and increased by the same amount the following day Friday as well to be quoted at 9.68%.
On Tuesday (June 19) call money rates remained unchanged at 10.61%, the same as in the previous (Monday, June 18). However on Monday, due to a combination of the Government’s commitment to service its foreign debt, import demand and general credit growth, resulted in CBSL having to hold its second consecutive reverse repo auction in as many days , which saw CBSL offering Rs. 1,000 million to the market and which was snapped up at a WAR of 9.58%, six bps more than the previous market day’s (June 15) figure of 9.52%, while call money rates hit the 10.61% level, five bps more than the previous.
There were however no reverse repo auctions on Tuesday, Wednesday and on Thursday, possibly due to the aforesaid policy actions by GoSL that has led towards a contraction in demand. However, GoSL was compelled to hold a reverse repo auction the following day Friday as the market ran short.