ER Shows Signs Of Settling Down
- But Rates To Go Higher, Higher
The foreign exchange (forex) market saw the US dollar ($) in the first three days of last week (Tuesday was a Poya holiday for the market) being traded within the Rs. 133.25-134.00 range in spot, interbank trading, with a source telling this reporter on Thursday that if the market could hold on to those levels for the next 2-3 weeks it may bring stability to the exchange rate (ER) at those levels.
Probably complementing this seemingly prophetic statement, the ER further strengthened to the Rs. 133.20/133.50 in two way quotes in interbank trading on Friday.
“In recent times we used to see wild fluctuations in the local currency, sometimes depreciating by as much as Rs. 2 in a day and even gaining also by that amount in a day vis-à-vis the $, but these wide changes in the ER were missing last week, it operated within that aforesaid narrow band comparatively speaking,” he said.
The impact of oil imports caused by the prevailing drought for power generation? The positive feature in this connection is that of late oil prices have been falling, the source said.
However President and Finance Minister Mahinda Rajapaksa supported by his two lieutenants, Central Bank of Sri Lanka (CBSL) Governor Ajith Nivard Cabraal and Treasury Secretary Dr. P. B. Jayasundera are reported to have had said that the ER should settle at the Rs. 125 level or below. At the other end of the spectrum the opposition UNP has had said that the ER will end at the Rs. 140 levels.
But the source said that interest rates were on an upward trend as witnessed at Wednesday’s (July 4) Treasury (T) Bill auction, where the weighted average yields ( WAYs) of 91, 182 and 364 day maturing T Bills rose by eight, 16 and 11 basis points (bps) each to 11.20%, 12.77% and 12.99% respectively.
“This is to be expected when considering the fact that inflation is at the 9.3% levels, coupled with CBSL’s high volume of T Bill holdings,” he said. CBSL has an over Rs. 200 billion stock of T Bill holdings, signifying that that amount of new money has been released to the economy with no compensatory gain in terms of equivalent forex inflows.
That sort of money printing causes inflationary pressure on the economy, ie tending prices to rise, hurting the poor and the fixed wage earner the hardest.
However that may be, with exporters entering the forex market “ by a ‘seemingly wider’ presence,” the ER marginally strengthened to the Rs. 133.40/133.80 levels in two way quotes in spot, interbank trading against the $ on thin volumes the previous day Wednesday’s (July 4), a source said.
On Monday (July 2) it closed at the Rs. 133/60/90 levels in two way quotes. Tuesday July 3 was a Poya holiday for the market.
With banks’ net open position restricted by two thirds by Government of Sri Lanka (GoSL) controlled CBSL’s strictures, coupled with them not wanting to enter into swaps due to the volatility of the ER, volumes returned at Wednesday’s interbank trading were low, he said.
Forex trades nowadays generally complement import demand and are not linked to banks taking positions or going in for swaps, the source said. Their positions these days are squared. Earlier this year CBSL cut banks’ net open position by two thirds in a bid to curb the ER from falling. However this action has had little or no effect on the ER. Since President Rajapaksa administratively devalued the ER by Rs. 3.70 when announcing Budget 2012 in Parliament on November 21, followed by its almost free float three months later on February 9, the ER in the interim near eight month period, ie from November 21, 2011 to July 5, 2012 has depreciated by Rs. 23.40 or by 21.2%.
Prior to Budget 2012, CBSL had had been administratively defending the ER at the Rs. 110.20 levels at the expense of depleting its forex reserves due to import demand.
However that may be, a weak rupee makes imports more expensive, made worse by the fact that Sri Lanka is an import dependent economy, thereby making the prices of essential goods such as petroleum based products like oil to sugar to pharmaceuticals more expensive to the consumer.
On the other hand a weak rupee is a boon to exporters and remittance recipients as they get more rupees for their $s.
According to GoSL controlled Statistics Department, inflation, as measured by the point to point change in the Colombo Consumers’ Price Index, increased by 2.3 percentage points over May to 9.3% last month, buttressed by high energy prices in the local market as mentioned below together with a depreciating rupee.
In addition to the free float of the ER, GoSL in a move to further curb pressure on the ER, coupled with an attempt to relieve the burden of its loss making energy utilities, in the past few months, raised the administered prices of energy, increased its policy rates, limited credit growth to 18% this year *(private sector credit by banks grew by 34.5% last year) and raised the administered prices on a host of other essentials such as bread, milk food, cement and bus fares.
On the positive side, a possible relief to ease pressure on the ER is the decline in petroleum prices in international markets due to the euro zone crisis that has seen a contraction in demand for oil in that region as a result. A sizeable chunk of Sri Lanka’s imports too comprise petroleum fuels.
Meanwhile the WAYs of T Bills continued on its upward journey, a feature that has become common since the depreciation of the administered price of the ER on November 21.
At Wednesday’s weekly T Bill auction, the WAYs of 91, 182 and 364 day maturing T Bills rose by eight, 16 and 11 bps each to 11.20%, 12.77% and 12.99% respectively. Since the announcement of Budget 2012 in Parliament eight months ago that led to their rise coinciding with the rupee devaluation, those respective T Bill WAYs to date have had gone up by 369, 523 and 540 bps respectively.
An increase in T Bill yields means that GoSL’s borrowing costs too having had gone up by that equivalent amount. Such increases also have a direct impact on market interest rates. As it’s, according to CBSL data, commercial banks’ average weighted prime lending rate (AWPR), the rate at which it lends to blue chip clients, as at June 29, has had gone up by 417 bps year on year (YoY) to 13.39%.
CBSL’s data on commercial banks’ average weighted lending rate (AWLR) however is not quite up to date, with the latest figures available being only up to April. That shows that the AWLR YoY has had gone up by 65 bps to 14.36%.
When borrowing rates increase that affects investments while at the same time causing pressure on banks’ non performing loans to rise, a fact confirmed by a banker attached to one of the top commercial banks in the island (see the business editorial in The Sunday Leader issue of 24.6.12).
And when investments retard, it imperils job growth, factory ouput and earnings.
However a source said that allowing interest rates to rise was GoSL’s/CBSL’s mechanism to curb pressure on the ER and on the country’s balance of payments position by making borrowing costs, for the purpose of buying $s more expensive, which, ipso facto, at least theoretically, would lead to a lessening in demand for the greenback.
Meanwhile a source said that trades in the forex market at the beginning of last week (Monday, July 2) were done in the Rs. 133.60-133.80 range to the $ in spot, interbank trading, the same as that of the previous market day (June 29).
Volumes however were” thin,” he said. market liquidity on June 29 contracted by Rs. 11,068 million to Rs.8,058 million over the previous market day’s (June 28 ) amount-see also the business pages of this newspaper’s last week’s edition, while rates edged up marginally, with the weighted average rate (WAR) of call money transactions going up by six bps to 10.39%, the WAR of overnight (o/n) market repurchase transactions by seven bps to 9.45% and the WAY of the o/n repo auction by two bps to 9.28%. Market’s excess liquidity on Monday (July 2) was Rs. 9,262 million, slightly higher than the previous day’s Rs. 8,058 million figure. In the following market day, ie Wednesday July 4, market’s excess liquidity, possibly due to inflows increased to Rs. 26,665 million. But this increase in excess liquidity didn’t lead to rate reductions, with WAR of call rates merely decreasing by one bp over the previous market day’s (Monday’s) figure to 10.47%, while the WAR of o/n market repurchase transactions stagnated at 9.43%, on the other hand the WAY in the o/n repo auction increased by four bps to 9.27%.
On Thursday, market’s excess liquidity declined to Rs. 21,865 million and so too call rates, by seven bps to 10.40% and o/n market repurchase transactions (borrowings backed by giving gilt edged T Bills as security) at a slower pace, by two bps to 9.41%. However the o/n repo auction rate seemingly went against the tide by increasing by four bps over Wednesday’s figure to 9.31%.
While on Friday excess liquidity further contracted to Rs. 15,417 million and call rates climbed by three bps to 10.43% with market repurchase transactions also rising by a similar amount to 9.44%, while the repo auction rate stagnated at 9.31%. Additionally CBSL conducted a seven day term repo auction which drained out Rs. 3,800 million; ie part of that excess liquidity at a 9.40% rate, ie nine bps more than the o/n repo auction rate. Meanwhile CBSL last week announced that its monthly policy review on the economy would be released on Wednesday, instead of the earlier announced date of Tuesday. What is generally looked at in these reviews is whether there are any changes in CBSL’s policy rates, the repo and the reverse repo, ie the o/n rate at which it “borrows” and the rate at which it lends to commercial banks respectively. Changes in these rates have an impact on market interest rates. So far for the year CBSL has had increased its policy rates twice with its current policy rates for the repo being at 7.75% and the reverse repo at 9.75%.
*It could be raised by a further 5% provided that that additional funding is from offshore sources.