High Interest Rates Here To Stay

  • CBSL In Money Printing Game

An analysis of the money market’s excess liquidity which swelled by Rs. 14,844 million (39.86%) to Rs. 52,084 million on Tuesday (February 5)-over that of Friday, February 1 excess liquidity figure of Rs. 37,240 million; showed that 67% (Rs. 9,965.76 million) of this increase on an overnight (o/n) basis came from money printing (see below), while only the balance being accounted as foreign exchange (forex) inflows.
Monday, February 4 was a holiday for the market on account of Independence Day.
However market’s excess liquidity declined by 13.9% (Rs. 7,233 million) to Rs. 44,851 million the following day Wednesday (February 6), possibly due to a submarket operation by the Government of Sri Lanka (GoSL) in relation to the settlement of an external commitment, such as paying off an oil bill, where it generally borrows the required rupees from the market, thereby creating a dent in the market’s excess rupee liquidity, but obtains the necessary forex to make such settlement, not from the market, but from Central Bank of Sri Lanka’s (CBSL’s) forex reserves in a non transparent manner, after paying it the rupees borrowed from the market in lieu, an exercise by GoSL/CBSL in order to give stability to the exchange rate (ER) by refraining from buying the necessary forex from the market in respect of such settlements-see also page 34.
On Thursday, the money market’s excess liquidity further dropped by 35.8% (Rs. 16,071 million) to Rs. 28,780 million; due to possible actions as described above, before again  falling to Rs. 15,210 million (ie by Rs. 13,570 million or by 47.2%) by the weekend. Ideally, market’s excess liquidity should be complemented by high inflows, and not from the money printing exercise that CBSL has indulged in as shown below.
When inflows, preferably in the form of higher exports or increased remittances or foreign direct investments (which are all cost free) take place, rather than through the accumulation of foreign commercial debt (which is a cost to the economy), and are bought by CBSL in return, that strengthens CBSL’s reserves which in turn may help to stabilise the ER, while at the same time providing confidence to foreign investors, at least about the stability of the island’s ER regime. Further, the accumulation of forex reserves may also help CBSL to control the market’s rupee liquidity.  In the event of excess liquidity it may sell forex to the market and absorb that excess rupee liquidity in turn, thereby mitigating inflationary pressure on the economy.
And in the event of a liquidity shortfall in the market, it may then buy forex from the same (if that doesn’t disturb the ER) and sell rupees in exchange, thereby fixing the liquidity problem, or otherwise offer liquidity to the market through its reverse repo window so as to not disturb the equilibrium in the forex market.
CBSL indulges in money printing to meet the Treasury’s borrowing requirements, by offering rates cheaper than that which is offered by the market (ie if there is an interest rate component attached at all), with the most likely possibility being that those T Bills subscribed to by CBSL, come at no extra cost to GoSL/Treasury.
Nevertheless in such an exercise, CBSL buys Treasury (T) Bills and lends rupees to the Treasury in return, in a seemingly non transparent manner, where even if there is an interest component affixed to such Government borrowings, neither the public nor the market knows the cost of such borrowings.
Also, CBSL buying T Bills from the Treasury is an indication that the market’s liquidity crisis is far from over, and with it the message, that the high interest rate regime currently besetting the economy is by no means on the wane.
And, as if to prove this point, commercial banks’ average weighted prime lending rate in the week ended Friday increased by two basis points (bps) week on week to 14.35%.  A year ago it was a mere 11.54%, CBSL data showed.
When market has excess liquidity complemented by money printing as shown aforesaid, it also causes inflationary pressure on the economy.  And, as an inducement for people to save in a high inflationary economy, banks and similar financial institutions then begin offering higher deposit rates over that of inflation, as an enticement for consumers to save.
That in turn leads to the creation of a high interest lending rate scenario as financial institutions would like to keep a margin over its deposit rates in order to profit from their business.
But high lending rates may result in the rise in bad debts in the financial sector, thereby threatening its very stability and the attendant evils that such ramifications brings forth.
Further, a high interest rate environment also acts as a disincentive to investments due to the high borrowing costs involved.  That in turn hurts revenue, not least government revenue (due to low profits made by corporates under such circumstances, thereby less tax income), exports and job creation, with it, leading to political and social instability.
Meanwhile, as a result of this recent money printing exercise, CBSL’s T Bill holdings on a gross basis increased by Rs. 9,965.76 million to Rs. 182,889.73 million on Tuesday, over that of last Friday’s closing figure of Rs. 172,923.97 million. This Rs. 9,965.76 million is equivalent to a 5.76% increase in CBSL’s T Bill holdings on an o/n basis.
If this pace of increase is considered as a harbinger of things to come, then it does not augur well for a rate reduction, nor as being the ideal solution to help solve the market’s liquidity crisis.
However the following day Wednesday, this figure dropped by Rs. 10,001.55 million (5.5%) to Rs. 172.888.18 million, probably due to the retirement of a maturing stock of CBSL’s T Bill holdings of an equivalent value, where CBSL didn’t resubscribe to the same.
This was repeated on Thursday (February 7), with CBSL’s T Bill holdings dropping by a further Rs. 5,984.17 million (3.5%) to Rs. 166,904.01 million on that day, before closing last week at Rs. 157,531.65 million. This further decline in CBSL’s T Bill holdings is due to Friday’s settlement with the market in respect of the outright sale of Rs. 5,000 million worth of T Bills to the latter by CBSL which matures on 22.2.13., while the balance Rs. 4,372.36 million may have had been due to the retirement of T Bills of an equivalent value and amount, which also would have had matured on Friday.

Policy Rates

In the meantime, increased market liquidity on Tuesday (February 5), brought about by the purchase of foreign inflows into the Government securities market and to the Colombo stock market by CBSL, coupled with CBSL buying T Bills, however didn’t act as a salve to bring down rates as expected, with T Bills and Bonds in secondary market trading remaining unchanged over that of the previous day (Friday, February 1) figures on thin trading and continuing in the same vein the following day Wednesday (February 6) and also on Thursday and Friday (February 8) as well.
A source told this newspaper that with CBSL’s Monetary Policy Board due to release their monthly policy review report on Tuesday (February 12), money market investors were looking for direction in that score before making their next move.
CBSL cut its key policy rates, the repo and the reverse repo by 25 bps each in December, the o/n repo to 7.50% and the reverse repo to 9.50% respectively, but kept those rates unchanged last month.
He said that while some players’ expectations were that CBSL will announce a policy rate cut on Tuesday, he however was unsure that that would take place, considering the near double digit inflation (9.8%) besetting the economy. Loose monetary policy (ie policy rate cuts), in a high inflationary environment, helps to keep inflationary pressure on an upward momentum due to the availability of cheap credit, thereby hitting the poor, the vulnerable and the fixed wage earner the hardest, as inflation is the measurement of the price movements of basic commodities and services.
An upward movement of inflation signifies that those prices are on the/have increase/d. He further said that while T Bills of the “shorter” 2014 maturity marginally declined by five bps to 11.05% on Tuesday (February 5) over that of last Friday’s (February 1) close, T Bonds of the shorter 2014 maturity stagnated at the 10.80% range, while that of the 2018 maturing T Bond remained at the 10.70-80% range.
The story the following day Wednesday too was the same, despite the fact that the T Bill auction of that day saw the weighted average yield (WAY) of T Bills of 91 day maturity fall by 22 bps to 9.25%, that of the 182 day by 12 bps to 10.16%, while that of the 364 day maturity stagnated at the 11.11% level, with the auction results having had no impact in secondary market T Bills and Bonds trading.
A source said that T Bill yields had had reached a nadir, after dropping sharply in recent times. The T Bill yield of a year’s maturity which until recently was in the 13-14% level, has since dropped to the 10-11% level, while the T Bond of 2017 maturity which previously was in the 14.40% level has since come down to under 11%, he said.
With inflation at 9.8% it’s unlikely that yields will drop further, the source said.  He further predicted that when CBSL’s Monetary Board releases its monthly policy review on Tuesday, policy rates would be kept unchanged. Usually, due to the perceived risks involved with time, T Bonds of longer maturity should command higher yields than those of shorter maturities.
But the contradiction in the local market, where, at least the 2018 T Bonds were commanding yields that were lower than those of a shorter tenure was because CBSL recently brought forth a ruling, allowing foreigners to invest only in T Bonds of maturity of five years and beyond in the case of new issues.
Foreigners are now not permitted to also invest in new T Bill issues. As a result of these restrictions, demand has been created for T Bonds of 2018 maturity, thereby making its yields to come down.


The ER on Friday weakened to the Rs. 126/25/35 level in interbank spot trading against the US dollar ($) on the back of import pressure on moderate volumes, the source said.
On the previous day Thursday (February 7), the ER, boosted by forex selling, an indicator of the possible receipt of inflows, strengthened to the Rs. 125.90 levels against the $ in interbank spot trading, before weakening to the Rs. 126.20 level, thereby reestablishing Wednesday’s status quo, by being undermined by buying pressure (imports) later during that day and also by buying by the two state banks-albeit in nominal quantities.
Meanwhile the ER at Wednesday’s (February 6) trading marginally strengthened to the Rs. 126/20 levels over that of the previous day Tuesday’s close on the back of inflows, the source said.
State names, namely People’s Bank and Bank of Ceylon were however on the buying side in the market, buying forex in nominal quantities, but it  wasn’t sure whether those purchases were made to meet their requirements or that of the government’s, he said. If there was aggressive forex buying from the state, the ER would have had deteriorated, the source said.
The ER on Tuesday declined by 10 Sri Lanka cents over that of its previous day’s close (Friday, February 1) to Rs. 126.40 to the $ in interbank spot trading on the back of import pressure, a source said.
Monday because of Independence Day was a holiday for the forex market.


With this week being the Chinese New Year (most foreign investors in the local market operate through their offices in Hong Kong, Singapore, et al, in which countries the majority population is Chinese), coupled with profit taking, a source therefore expected trading to be dull in the new week beginning tomorrow.
On Friday, turnover was taken up to Rs. 1.95 billion, on the back of foreign selling (local buying) in Hatton National Bank plc (HNB).
This transaction contributed some Rs. 572 million to the day’s trading (four million shares at Rs. 143 a share).
Another noteworthy contribution to the day’s turnover came from the allegedly controversial “Greig” (Environmental Resources) stock.  However that may be, the ASPI closed the week at 5,850.67 points, up 0.69% over its previous day’s close and the S&P SL 20 Index was up by 0.80% to close last week at 3,269.61 points.  The bourse on the previous day Thursday (February 13) too saw foreign activity in HNB, Commercial Bank of Ceylon plc (Com Bank), John Keells Holdings plc (JKH) and Sampath Bank plc which resulted in a Rs. 160.2 million net foreign inflow (NFI), whilst simultaneously reducing the net foreign outflow (NFO) experienced during the period 1.1.13. to 7.2.13. to Rs. 760.2 million.
But by Friday (8.2.13.) NFO had increased to Rs. 1.1 billion. Thursday’s turnover was Rs. 1.5 billion, while the ASPI gained by 0.52% over the previous day Wednesday’s close to finish Thursday at 5,810.42 points and the S&P SL 20 Index gained by 0.82% to close at 3,243.70 points. However retailers continued to keep away from the bourse (see also this newspaper’s last week’s business pages). On Wednesday, the bourse, operating under the shadow of a high interest rate regime and in the absence of retail investors, recorded a Rs. 1.2 billion turnover, boosted by a foreign sale in HNB amounting to Rs. 562 million.
The ASPI declined by 0.02% to close Wednesday at 5,780.09 points, while the S&P SL 20 Index gained by 0.42% to close at 3,217.39 points. The previous day Tuesday (February 5) it recorded a nominal Rs. 447.3 million turnover.  The ASPI fell by 0.32% to close that day at 5,781.30 points; while the S&P SL 20 Index marginally increased by 0.22% to close Tuesday at 3,203.91 points. Monday was a holiday for the bourse on account of Independence Day.

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